# Chapter 08 adjusted.ppt - CHAPTER 8 Risk and Rates of...

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8-1 CHAPTER 8 Risk and Rates of Return Stand-alone risk Portfolio risk Risk & return: CAPM / SML

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8-2 Investment returns The rate of return on an investment can be  calculated as follows: (Amount received – Amount invested) Return =       ________________________                                                    Amount invested For example, if \$1,000 is invested and \$1,100 is  returned after one year, the rate of return for this  investment is:  (\$1,100 - \$1,000) / \$1,000 = 10%.
8-3 What is investment risk? Two types of investment risk Stand-alone risk Portfolio risk  Investment risk is related to the probability  of earning a low or negative actual return. The greater the chance of lower than  expected or negative returns, the riskier the  investment.

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8-4 Probability distributions A listing of all possible outcomes, and the  probability of each occurrence. Can be shown graphically. Expected Rate of Return Rate of Return (%) 100 15 0 -70 Firm X Firm Y
8-5 Comments on standard  deviation as a measure of risk Standard deviation ( σ i ) measures total,  or stand-alone, risk. The larger  σ i  is, the lower the  probability that actual returns will be  closer to expected returns. Larger  σ i  is associated with a wider  probability distribution of returns.

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8-6 Investor attitude towards risk Risk aversion – assumes investors dislike  risk and require higher rates of return to  encourage them to hold riskier securities. Risk premium – the difference between  the return on a risky asset and a riskless  asset, which serves as compensation for  investors to hold riskier securities.
8-7 Portfolio construction:

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## This note was uploaded on 09/08/2010 for the course BUS 170 at San Jose State.

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Chapter 08 adjusted.ppt - CHAPTER 8 Risk and Rates of...

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