05-Risk-returns - Risk and Return Stand-alone risk...

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Risk and Return  1 Risk and Return Stand-alone risk Portfolio risk Risk and return: CAPM/SML Changes in inflation & risk aversion
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Risk and Return  2 What is investment risk? Investment risk pertains to the probability of earning less than the expected return. The greater the chance of low or negative returns, the riskier the investment.
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Risk and Return  3 Probability distribution Expected Rate of Return Rate of return (%) 100 15 0 -70 Firm X Firm Y
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Risk and Return  4 Investment Alternatives (Table shows returns under different economic states.) Economy Prob. T-Bill HT Coll USR MP Recession 0.1 8.0% -22.0% 28.0% 10.0% -13.0% Below avg. 0.2 8.0 -2.0 14.7 -10.0 1.0 Average 0.4 8.0 20.0 0.0 7.0 15.0 Above avg. 0.2 8.0 35.0 -10.0 45.0 29.0 Boom 0.1 8.0 50.0 -20.0 30.0 43.0 1.0
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Risk and Return  5 Why is the T-bill return independent of the economy? T-bills will return the promised 8%, regardless of the state of the economy.
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Risk and Return  6 Do T-bills promise a completely risk-free return? No T-bills are still exposed to the risk of unexpected inflation. However, not much unexpected inflation is likely to occur over a relatively short period.
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Risk and Return  7 Do the returns of High Tech and Collections move with or counter to the economy? HT : With. Positive correlation . Typical. Coll : Countercyclical. Negative correlation . Unusual.
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Risk and Return  8 R = Σ R i P i Calculate the expected rate of return on each alternative R = Expected rate of return R HT = (-22%)0.10 + (-2%)0.20 + (20%)0.40 + (35%)0.20 + (50%)0.10 = 17.4% . ^ ^ ^ i = 1 n
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Risk and Return  9 HT appears to be the best, but is it really? ^ R HT 17.4% Market 15.0 USR 13.8 T-bill 8.0 Coll. 1.7
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Risk and Return  10 What’s the standard deviation of returns for each alternative? σ σ 2 = variance = - n 1 = i i 2 i P ) R (R = σ = standard deviation
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Risk and Return  11 - σ n 1 = i i 2 i P ) R (R = σ T-bills = 0.0%. σ HT = 20.0%. σ
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05-Risk-returns - Risk and Return Stand-alone risk...

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