Lecture 4_Student_6slides

# Lecture 4_Student_6slides - T RE U RN CA N S RI K W EQ UA...

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1 FIN 221 Lecture 4 CH7:RISK and RETURN R E T U N I S K C A W Q F Y ? M X O G V L VE 2 • To be released at 12.30pm today • Assignment topic directly related to today’s lecture theme • Master today’s lecture content before you start the assignment. • You will be able to post assignment-related questions onto the e-learning discussion forum and I will answer it! • Mid-exam covers materials up to today’s lecture. Manual for FIN221 Assignment 3 Extra Tute Qs for next week In relation to the CAPM, indicate for each of the following statements whether it is true or false and explain why. (a) In equilibrium, all risky assets are priced such that their expected return lies on the security market line. (b) Two securities with the same required returns can have different betas. (c) Two securities with the same standard deviations can have different betas. (d) Two securities that have the same correlation coefficients with the market portfolio will have the same beta. 4 Relevant Reading Chapters •7 .1 .2 .3 - Calculating variance and standard deviation Interpreting variance and standard deviation .4 .5 .6 .7 –Secur ity Market Line 5 Asset Valuation CF = PV (1+i) CF CF 2 CF 3 CF n n k=1 K CF CF 1 k • What are the three key variables needed in asset valuation? Future Cash flows Discount rate No of periods Å reflects the level of risk associated with future cash flows 6 Cash Flow Cash Flow Cash Flow PV PV PV (1+i) n R

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2 7 What are we learning today? How do we determine “ required rate of return for shareholders (=cost of equity) ”? • Relation between RISK and RETURN • Computation of Expected Return for Definition and quantification of total risk for i) Individual securities ii) Portfolios of securities • Demonstrate how portfolios reduce risk • Is there a pricing model which can explain or predict the required rate return for a stock? – Capital Asset Pricing Model YES 8 Definitions • Portfolio (P) – The collection of assets an investors owns • Probability – The chance that the event will occur – Must sum to 1 or 100% Stock i i 2 i 3 i 4 i 1 9 Total Holding Period Return (R T ) • When people refer to the return from an investment, they are generally referring to the TOTAL RETURN over some investment period or holding period Æ Total holding period return 26.5 28 P 0 P 1 CF 1 =\$1 10 1 T 0 PP C F R P −+ = Return from capital appreciation=R CA Return from Income=R I __________ = 10 Expected Returns • An average of the possible returns from an investment, where each return is weighted by the probabilility that it will occur • Can be computed using two types of data – Probability data – Historical data 11 Expected Return : Single Asset (i) -Probability Data E(R Asset )= P i x R i 9% 10% 11% 12% 13% 0.1 R i P i n i=1 E(R Asset )= ()( 0.09 ) + 0.10 ) + 0.11 ) + 0.12 ) + 0.13 ) = ___% 0.2 0.4 0.2 0.1 12 Expected Return : Single Asset (i) -Historical Data
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Lecture 4_Student_6slides - T RE U RN CA N S RI K W EQ UA...

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