BCOR 2200 Chapter 11 w cq - Chapter 11 Risk and Return 1...

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Chapter 11 Risk and Return 1
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Chapter Overview Last chapter we looked at risk and return for CATEGORIES of stocks (large and small) This chapter we look risk and return in more detail Risk and return calculations for individual stocks Risk and return calculations for a portfolio of stocks Specific Skills Calculate expected returns and risk Understand the impact of diversification Understand the systematic risk principle Understand the security market line Understand the risk-return trade-off 2
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Chapter Outline Calculate returns and risk (variance and standard deviation) for individual stocks Calculate returns and risk for portfolios Expected Values and Actual Announced Values The difference between them is called the Surprise Announcements by companies, the government… Two components of Risk “Systematic” and “Unsystematic” How Diversification lowers Portfolio Risk Measuring Systematic Risk with Beta The Security Market Line (SML) The SML and the Cost of Capital: A Preview 3
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Risk and Return Calculations Two ways to deal with expected values Depending on how the data is presented We’ll consider height First Way: We have a large sample of data: Get everybody’s height (measure or ask?) Calculate the mean and σ : The MEAN height is the EXPECTED height 4 Height H = ( 29 ( 29 ( 29 ( 29 ( 29 [ ] H H H H H H 1 N 1 1 N H H H Var 2 N 2 2 2 1 N 1 i 2 i 2 - + + - + - - = - - = = = σ ( 29 2 Var(H) H SD σ σ = = = ( 29 + + + = = = = N R R R N H H E(H) N 2 1 N 1 i i 1 1
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Risk and Return Calculations (Part 2) Second Way: Set categories or ranges of height Calculate mean for each category Calculate (or assign) probabilities for each category Calculate expectation: E(H) = 66.3 inches Why might this way be better? You can change category probabilities based on new information or expectations Intramural basketball meeting, so reset probs to 10%, 10% and 80% New E(H) = 70.3 inches = = N i i i H p H E 1 ) ( 5 Category (i) Prob ( p i ) Inches (H i ) p i H i Lowest 30% 61 18.3 Middle 40% 66 26.4 Highest 30% 72 21.6 Sum 100% 66.3
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Clicker Question: The table shows the group averages and probabilities of observing someone from each group. Calculate the expected height for the next person to walk into the room for the general population and for an intramural meeting basket ball meeting. 6 Group Average height in Group Probabilities for General Population Probabilities for Intramural Basketball Tall 74 25% 50% Middle 66 50% 40% Low 60 25% 10% General Population Intramural Basketball A. 18.5 37.0 B. 33.0 26.4 C. 66.5 66.7 D. 66.7 66.7 E. 66.5 69.4
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Clicker Answer: General Population: E(H) = 0.25(60) + 0.50(66) + 0.25(74) = 66.5 Intramural Basketball: E(H) = 0.10(60) + 0.40(66) + 0.50(74) = 69.4 The Answer is E. The benefit to this method: You can adjust your calculation to produce an expected height that is more inline with your understanding of the situation If you know something about the next group in the room, you can adjust your expectation calculation 7
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Risk-Return Calculation Outline: 11.1 Single Stock Notation
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