(10) CH11 Lecture Slides.pptx - FIN 371 Financial Management CHAPTER 11 RISK AND RETURN PROFESSOR JARED I WILSON Chapter 11 Objectives CALCULATE

(10) CH11 Lecture Slides.pptx - FIN 371 Financial...

This preview shows page 1 - 15 out of 60 pages.

FIN 371: Financial Management CHAPTER 11: RISK AND RETURN PROFESSOR JARED I. WILSON
Image of page 1
Chapter 11 – Objectives CALCULATE EXPECTED RETURNS AND STOCK VARIANCE DESCRIBE THE IMPACT OF DIVERSIFICATION DIFFERENTIATE SYSTEMATIC AND UNSYSTEMATIC RISK CALCULATE THE SECURITY MARKET LINE
Image of page 2
Historical Average vs. Expected Return Both provide useful insight about assets of interest Historical average return Does not take into consideration possible economic outcomes Can give some insight about the future BUT , not perfect We want to know what will happen in the future Expected return
Image of page 3
Expected Returns Weighted average of the possible outcomes based on the probability that each outcome will occur Realized return may be very different from expected return Expected return
Image of page 4
Expected Returns Example Determine the expected returns of the following: U.S. Treasury Bill (risk-free rate) Alphabet (technology firm) Pepsi (beverage & food company) Wal-Mart (retailer) S&P 500 (stock market index)
Image of page 5
Expected Returns Example Probability distribution of stock returns Economy Probability T-Bill Alphabet Pepsi Wal-Mart S&P 500 Recession 10% Below average 20% Average 40% Above average 20% Boom 10% 100%
Image of page 6
Expected Returns Example
Image of page 7
Expected Returns Example What is the expected risk premium?
Image of page 8
Expected Returns In Class Problem Suppose that you have predicted the following returns for stocks C and T in three possible states of natureWhat is the probability of a recession?What are the expected returns of stocks C and T?If the risk-free rate is 2.5%, what is each stock’s risk premium?StateProbabilityCTBoom30%15%25%Normal50%10%20%Recession???2%1%
Image of page 9
Expected Returns In Class Problem What is the probability of a recession?What are the expected returns of stocks C and T?If the risk-free rate is 2.5%, what is each stock’s risk premium?
Image of page 10
Variance and Standard Deviation Variance and standard deviation measure volatility of returns Now we have to consider the probability of different outcomes Weighted average of squared deviations
Image of page 11
Variance Example Calculate the variance of Alphabet’s possible returns Economy Probability (A) Returns (B) Expected Return (C) Deviation (D)=(B)-(C) Squared Deviation (E)=(D) 2 Probability x Squared Deviation (F)=(A)x(E) Recession 10% -22.0% 17.4% Below average 20% -2.0% 17.4% Average 40% 20.0% 17.4% Above average 20% 35.0% 17.4% Boom 10% 50.0% 17.4% 100%
Image of page 12
Variance Example Calculate the variance of Pepsi’s possible returns Economy Probability (A) Returns (B) Expected Return (C) Deviation (D)=(B)-(C) Squared Deviation (E)=(D) 2 Probability x Squared Deviation (F)=(A)x(E) Recession 10% 28.0% 1.74% Below average 20% 14.7% 1.74% Average 40% 0.0% 1.74% Above average 20% -10.0% 1.74% Boom 10% -20.0% 1.74% 100%
Image of page 13
Variance In Class Problem
Image of page 14
Image of page 15

You've reached the end of your free preview.

Want to read all 60 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture