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IF Risk &amp; Return and Portfolio Theory - Lecture

# IF Risk &amp; Return and Portfolio Theory - Lecture -...

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Click to edit Master subtitle style  11/6/09   ©  2003-2009 Mehmet Yalin Risk & Return and Portfolio Theory

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11/6/09   ©  2003-2009 Mehmet Yalin Chapter 12 Some Lessons from Capital Market History 22  Chapter 12
11/6/09   ©  2003-2009 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 > RT-BILLS Monthly 1929-2008: 0.53% for S&P 500 vs. 0.30% for T-Bills - RSMALL COMPANIES > RLARGE COMPANIES Monthly 1939-2008: 1.25% for CR vs. 1.04% for GE 33  Chapter 12

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11/6/09   ©  2003-2009 Mehmet Yalin 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   ©  2003-2009 Mehmet Yalin example 1 on measuring return You bought a 20-year 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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11/6/09   ©  2003-2009 Mehmet Yalin 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   ©  2003-2009 Mehmet Yalin example 3 on measuring return A company is planning to issue a 5-year bond with \$1,000 face value and 10% coupon rate with annual coupon payments at 14% yield-to-maturity now. What is the expected dollar return of this bond over the next year if yield-to-maturity 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  Chapter 12

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11/6/09   ©  2003-2009 Mehmet Yalin 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  Chapter 12
11/6/09   ©  2003-2009 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 3-day return? (b) What would be the APR and EAR assuming a 363-day year?

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