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11/6/09
© 20032009 Mehmet Yalin
Risk & Return
and Portfolio Theory
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Chapter 12
±
Some Lessons from Capital Market History
22
Chapter 12
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© 20032009 Mehmet Yalin
relationship between risk and return (I )
v
An investment’s required return depends on its risk.
 There is a reward for bearing risk so return and risk
are positively correlated.
v
Historically, we have observed that
 RSTOCKS > RTBILLS
Monthly 19292008: 0.53% for S&P 500 vs. 0.30% for
TBills
 RSMALL COMPANIES > RLARGE COMPANIES
Monthly 19392008: 1.25% for CR vs. 1.04% for GE
33
Chapter 12
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relationship between risk and return
(I I )
44
Chapter 12
1
10
Investment of $1 between March 1986 and February 2009 into.
..
11/6/09
© 20032009 Mehmet Yalin
example 1 on measuring return
You bought a 20year bond with $1,000 face value and
15% coupon rate with annual coupon payments for
$1,224.08 exactly a year ago. Currently, the bond is selling
for $1,313.57. What is your dollar return over the past
year?
( 29
49
.
239
$
08
.
224
,
1
$
57
.
313
,
1
$
150
$
return
Dollar
=

+
=
gains
Capital
income
Dividend
return
Dollar
+
=
55
Chapter 12
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example 2 on measuring return
You bought a common share of a company for $80
exactly a year ago. Over the past year, the company paid
$2 a share in dividends. Currently, the stock is selling for
$100 a share. What is your percentage return over the
past year?
%
5
.
27
80
$
80
$
100
$
80
$
2
$
return
Percentage
=

+
=
( 29
yield
gains
Capital
yield
Dividend
return
Percentage
+
=
HPR
66
Chapter 12
11/6/09
© 20032009 Mehmet Yalin
example 3 on measuring return
A company is planning to issue a 5year bond with
$1,000 face value and 10% coupon rate with annual
coupon payments at 14% yieldtomaturity now. What is
the expected dollar return of this bond over the next year if
yieldtomaturity at the time is expected to be 12%?
( 29
( 29
( 29
( 29
( 29
57
.
176
$
68
.
862
$
25
.
939
$
100
$
return
Dollar
25
.
939
$
12
.
0
1
000
,
1
$
12
.
0
1
1
1
12
.
0
100
$
68
.
862
$
14
.
0
1
000
,
1
$
14
.
0
1
1
1
14
.
0
100
$
4
4
1
5
5
0
=

+
=
=
+
+
+

×
=
=
+
+
+

×
=
P
P
77
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example 4 on measuring return
A company has just paid $2 per share dividend, which is
expected to grow 10% a year forever. The appropriate
discount rate is 20% currently; however, it is expected to
increase to 25% in one year. What is the expected
percentage return of this company’s stock over the next
year?
( 29
( 29
%
682
.
16
22
$
22
$
13
.
16
$
22
$
20
.
2
$
return
Percentage
13
.
16
$
1
.
0
25
.
0
42
.
2
$
42
.
2
$
1
.
0
1
2
$
22
$
1
.
0
2
.
0
20
.
2
$
20
.
2
$
1
.
0
1
2
$
1
2
2
0
1

=

+
=
=

=
⇒
=
+
×
=
=

=
⇒
=
+
×
=
P
D
P
D
88
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© 20032009 Mehmet Yalin
example 5 on measuring return
You bought a share of Microsoft at the closing share
price of $29.97 on Friday, November 12, 2004. You sold
the share on Monday at the closing share price of $27.39
while the company paid out $0.08 regular and $3 special
dividend per share.
(a)
Ignoring transaction costs, what
was your 3day return?
(b)
What would be the APR and
EAR assuming a 363day year?
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This note was uploaded on 11/05/2009 for the course BUSFIN 1030 taught by Professor Zutter during the Fall '08 term at Pittsburgh.
 Fall '08
 ZUTTER

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