Chap5_2009 - Chapter 5 Risk and Return Learning Objectivs...

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Chapter 5 Risk and Return
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Learning Objectivs After studying Chapter 5, you should be able to: 1. Understand the relationship (or “trade-off”) between risk and return. 2. Define risk and return and show how to measure them by calculating expected return, standard deviation, and coefficient of variation. 3. Discuss the different types of investor attitudes toward risk. 4. Explain risk and return in a portfolio context, and distinguish between individual security and portfolio risk. 5. Distinguish between avoidable (unsystematic) risk and unavoidable (systematic) risk and explain how proper diversification can eliminate one of these risks. 6. Define and explain the capital-asset pricing model (CAPM), beta, and the characteristic line. 7. Calculate a required rate of return using the capital-asset pricing model (CAPM). 8. Demonstrate how the Security Market Line (SML) can be used to describe this relationship between expected rate of return and systematic risk. 9. Explain what is meant by an “efficient financial market” and describe the three levels (or forms) to market efficiency.
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• Assumptions in Solving Economic Analysis Problems • Economic Criteria • Applying Present Worth Techniques – Useful Lives Equal the Analysis Period – Useful Lives Different from the Analysis Period – Infinite Analysis Period Chapter Outline
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• Defining Risk and Return • Using Probability Distributions to Measure Risk • Attitudes Toward Risk • Risk and Return in a Portfolio Context • Diversification • The Capital Asset Pricing Model (CAPM) • Efficient Financial Markets Chapter Outline Chapter Outline
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Defining Return Income received on an investment plus any change in market price , usually expressed as a percent of the beginning market price of the investment. D t + ( P t - P t-1 ) P t-1 R =
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Return Example The stock price for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend . What return was earned over the past year?
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Return Example The stock price for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend . What return was earned over the past year? $1.00 + ( $9.50 - $10.00 ) $10.00 R = = 5%
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Defining Risk What rate of return do you expect on your investment (savings) this year? What rate will you actually earn? Does it matter if it is a bank CD or a share of stock? The variability of returns from those that are expected.
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(Discrete Dist.) R = ( R i )( P i ) is the expected return for the asset, R i is the return for the i th possibility, P i is the probability of that return occurring, n is the total number of possibilities. n
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Chap5_2009 - Chapter 5 Risk and Return Learning Objectivs...

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