Power Point Slides for the Lectures- Module 2- Risk and Retu

# Power Point Slides for the Lectures- Module 2- Risk and...

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1 TBS 907 Financial Strategy LECTURE NOTES- MODULE 2 Portfolio Theory and the Capital Asset Pricing Model (CAPM).

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2 Return There is uncertainty associated with returns from shares. Return is defined as total loss or gain experienced by an investor over a given period of time. Return is calculated by dividing the assets change in value plus any cash distributions ( dividends) during the period by its beginning-of-period investment value. Assume we can assign probabilities to the returns expected, given an assumed set of circumstances. ( 29 = = n i i i P R R E 1
3 Expected Return Calculation Distribution of returns for security Return Probability 0.09 0.1 0.10 0.2 0.11 0.4 0.12 0.2 0.13 0.1 Expected return = (0.09 × 0.1) + (0.10 × 0.2) + (0.11 × 0.4) + (0.12 × 0.2) + (0.13 × 0.1) = 0.11 or 11.0 per cent

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4 Risk Risk is present whenever investors are not certain about the outcome an investment will produce. Risk is defined as the chance of financial loss or more formally the variability of returns associated with a given asste. Risk is measured in terms of how much a particular return deviates from an expected return (variance or standard deviation): Standard deviation is the square root of the variance and is the most common indicator’s of an asset’s risk. It measures the dispersion around the expected value. ( 29 ( 29 = - = n i i i i P R E R 1 2 2 σ
5 Risk Calculation Calculation of the risk associated with security S: = √(.09 -.1129 2 (.129 + (.10 -.1129 2 (.229 + (.11 -.1129 2 (.429 + (.12 -. 1129 2 (.229 + (.13 -.1129 2 (.129 = √ .00012 = 1.095% (standard deviation)

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6 Coefficient of Variation This is one measure of dispersion and maybe useful in comparing assets with different expected returns. The higher the CV the greater the risk. The lower the value of CV the better k CV k σ =
7 Risk Attitudes The marketplace is made up of investors with different expectations as to the income and risks they are prepared to take to get those returns. Risk-neutral investor: one who neither likes nor dislikes risk Risk-averse investor: one who dislikes risk Risk-seeking investor: one who prefers risk

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8 Risk Attitudes (cont.) The standard assumption in finance theory is risk-aversion. This does not mean an investor will refuse to bear any risk at all. Rather an investor regards risk as something undesirable, but which may be worth tolerating if compensated with sufficient return.
9 Risk of Assets and Portfolios Investors usually invest in a number of assets (a portfolio) and will be concerned about the risk of their overall portfolio.

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Portfolio Theory Assumptions Investors perceive investment opportunities in terms of a probability distribution defined by expected return and risk. Investors’ expected utility is an increasing
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## This note was uploaded on 07/10/2009 for the course FIN FIN taught by Professor Dr. during the Spring '09 term at Baptist College of Health Sciences.

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Power Point Slides for the Lectures- Module 2- Risk and...

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