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Chapter_6_-_The_Returns_and_Risk_from_Investments

Chapter_6_-_The_Returns_and_Risk_from_Investments - The...

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The Returns and Risks From Investing Chapter 6 Charles P. Jones, Investments: Analysis and Management, Tenth Edition, John Wiley & Sons 6-1
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Asset Valuation Function of both return and risk ¾ At the center of security analysis How should realized return and risk be measured? ¾ The realized risk-return tradeoff is based on The realized risk return tradeoff is based on the past ¾ The expected risk-return tradeoff is uncertain and may not occur 6-2
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Return Components Returns consist of two elements: ¾ Periodic cash flows such as interest or dividends (income return) “Yield” measures relate income return to a price for the security P i i ti d i ti ( it l ¾ Price appreciation or depreciation (capital gain or loss) The change in price of the asset Total Return =Yield +Price Change 6-3
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What is risk? Risk is the chance that the actual outcome from an investment will differ from the expected outcome. Risk is often associated with the dispersion in the likely outcomes. ¾ Dispersion refers to variability, and the standard deviation is a statistical measure of variability or dispersion. 6-4
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Risk Sources Financial Risk Interest Rate Risk ¾ Tied to debt financing Liquidity Risk ¾ Affects income return Market Risk ¾ Marketability with-out sale prices E h R t Ri k ¾ Overall market effects Inflation Risk Exchange Rate Risk Country Risk Political stability ¾ Purchasing power variability Business Risk ¾ 6-5
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Risk Types Two general types: Systematic (general) risk ¾ Pervasive, affecting all securities, cannot be avoided Interest rate, market, inflation, exchange and country risks Nonsystematic or idiosyncratic (company ¾ specific) risk Unique characteristics specific to issuer Business, financial, liquidity risks 6-6 Total Risk = Systematic Risk + Idiosyncratic risk
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Measuring Returns E E B B D P P TR P + = For comparing performance over time or ac oss diffe ent sec ities across different securities Total Return is a percentage relating all cash flows received during a given time period flows received during a given time period, denoted CF t +(P E - P B ), to the start of period price, PB.
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