Topic 5 Risk & Return Part 1

Topic 5 Risk & Return Part 1 - Topic 5 Risk and...

Info iconThis preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon
Topic 5 Risk and Return – part 1
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Rates of return Historical return The return that an asset has already produced has already produced over a specified period of time Expected return The return that an asset is expected to produce expected to produce over some future future period of time Required return The return that an investor requires an asset requires an asset to produce to produce if he/she is to be a future investor in that asset
Background image of page 2
Dollar returns The gain (or loss) from an investment. Made up of two components: income, eg dividends, interest payments, capital gain (or loss). Total dollar return = dividend income + capital gain (or loss). Percentage returns                              Dividends paid at Change in market end of period + value over period Percentage return = Beginning market value
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Percentage return example P 0 = $37.00 P 1 = $40.33 D 1 = $1.85 ( 29 14% or 0.14 $37.00 $37.00 - $40.33 $1.85 Return % = + = Per dollar invested we get 5% in dividends ($1.85/$37) and 9% in capital gains ($3.33/$37) - a total return of 14%.
Background image of page 4
State of economy Recession Normal Boom Probability P 0.20 0.50 0.30 Return A B 4% 8% 14% -10% -10% 18% 18% 30% 30% Expected return R is just a weighted average R = P(R 1 ) x R 1 + P(R 2 ) x R 2 + … + P(R n ) x R n Calculating expected returns
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
State of economy Recession Recession Normal Normal Boom Boom Probability P 0.20 0.20 0.50 0.50 0.30 0.30 Return A B 4% 4% 8% 8% 14% 14% -10% 18% 30% Company A R = P(R 1 ) x R 1 + P(R 2 ) x R 2 + … + P(R n ) x R n R A = 0.2 x 4% + 0.5 x 8% + 0.3 x 14% = 9% Case study
Background image of page 6
State of economy Recession Normal Boom Probability P 0.20 0.50 0.30 Return A B 4% 8% 14% - -10% 18% 30% Company B Company B R = P(R 1 ) x R 1 + P(R 2 ) x R 2 + … + P(R n ) x R n R B = 0.2 x -10% + 0.5 x 18% + 0.3 x 30% = 16% Case study
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Risk How to measure risk Variance, standard deviation, beta How to reduce risk Diversification How to price risk Security market line, CAPM
Background image of page 8
For a Treasury security, what is the required rate of return? For  a  Treasury  security,  what  is  the  required rate of return? Risky  assets  on  average  earn  a  risk  premium, ie there is a reward for bearing risk. Required rate of return = = Risk-free Risk-free rate of rate of return return Reason Reason : : Treasury securities are free of default risk Treasury securities are free of default risk
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Required Required rate of rate of return return = = Risk-free Risk-free rate of rate of return return How large a risk premium should we require to How large a risk premium should we require to buy a corporate security? buy a corporate security? + + Risk Risk premium premium For a company security, what is the required rate of return?
Background image of page 10
What is investment risk? Typically, investment returns are not known with
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 12
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 53

Topic 5 Risk & Return Part 1 - Topic 5 Risk and...

This preview shows document pages 1 - 12. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online