chapter 2 portfolio - Chapter 2 Valuation Risk Return and...

Info icon This preview shows pages 1–13. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 2 Valuation, Risk, Return, and Uncertainty 1
Image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Introduction The occasional reading of basic material in your chosen field is an excellent philosophical exercise Do not be tempted to conclude that you “know it all” e.g., what is the present value of a growing perpetuity that begins payments in five years? 2
Image of page 2
Valuation Valuation may be the most important part of the study of investments Security analysts make a career of estimating “what you get” for “what you pay” The time value of money is one of the two key concepts in finance and is very useful in valuation 3
Image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Growing Income Streams A growing stream is one in which each successive cash flow is larger than the previous one A common problem is one in which the cash flows grow by some fixed percentage 4
Image of page 4
Growing Annuity A growing annuity is an annuity in which the cash flows grow at a constant rate g : 5 2 2 3 1 1 (1 ) (1 ) (1 ) ... (1 ) (1 ) (1 ) (1 ) 1 1 1 n n N C C g C g C g PV R R R R C g R g R
Image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Growing Perpetuity A growing perpetuity is an annuity where the cash flows continue indefinitely: 6 2 2 3 1 1 1 (1 ) (1 ) (1 ) ... (1 ) (1 ) (1 ) (1 ) (1 ) (1 ) t t t t C C g C g C g PV R R R R C g C R R g
Image of page 6
Safe Dollars and Risky Dollars A safe dollar is worth more than a risky dollar Investing in the stock market is exchanging bird-in- the-hand safe dollars for a chance at a higher number of dollars in the future 7
Image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Safe Dollars and Risky Dollars (cont’d) Most investors are risk averse People will take a risk only if they expect to be adequately rewarded for taking it People have different degrees of risk aversion Some people are more willing to take a chance than others 8
Image of page 8
Choosing Among Risky Alternatives Example You have won the right to spin a lottery wheel one time. The wheel contains numbers 1 through 100, and a pointer selects one number when the wheel stops. The payoff alternatives are on the next slide. Which alternative would you choose? 9
Image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Choosing Among Risky Alternatives (cont’d) 10 $100 $100 $100 $100 Average payoff –$89,000 [100] $550 [91–100] $0 [51–100] $90 [51–100] $1,000 [1–99] $50 [1–90] $200 [1–50] $110 [1–50] D C B A Number on lottery wheel appears in brackets.
Image of page 10
Choosing Among Risky Alternatives (cont’d) Example (cont’d) Solution: Most people would think Choice A is “safe.” Choice B has an opportunity cost of $90 relative to Choice A. People who get utility from playing a game pick Choice C. People who cannot tolerate the chance of any loss would avoid Choice D. 11
Image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Choosing Among Risky Alternatives (cont’d) Example (cont’d) Solution (cont d): Choice A is like buying shares of a utility stock.
Image of page 12
Image of page 13
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern