capm - 8-1CHAPTER 8Risk and Rates of ReturnThis chapter is...

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Unformatted text preview: 8-1CHAPTER 8Risk and Rates of ReturnThis chapter is relatively important.8-2Investment returnsThe rate of return on an investment can be calculated as follows:(Amount received Amount invested)Return = ________________________ Amount investedFor 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%.8-3What is investment 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. The greater the range of possible events that can occur, the greater the riskThe Chinese definitionTwo types of investment riskStand-alone risk (when the return is analyzed in isolation.)Portfolio risk (when the return is analyzed in a portfolio.)8-4PART I: Standard alone riskThe risk an investor would face if s/he held only one asset.8-5Investor attitude towards riskRisk aversion assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities.Who wants to be a millionaire?Risk premium the difference between the return on a risky asset and less risky asset, which serves as compensation for investors to hold riskier securities.8-6Selected Realized Returns, 1926 2001 Average Standard Return DeviationSmall-company stocks17.3%33.2%Large-company stocks12.720.2L-T corporate bonds 6.1 8.6L-T government bonds 5.7 9.4U.S. Treasury bills 3.9 3.2Source: Based on Stocks, Bonds, Bills, and Inflation: (Valuation Edition) 2002 Yearbook (Chicago: Ibbotson Associates, 2002), 28.8-7The Value of an Investment of $1 in 1926Source: Ibbotson Associates0.11010001925 1940 1955 1970 1985 2000S&PSmall CapCorp BondsLong BondT BillIndexYear End16402258764.148.916.68-8Rates of Return 1926-2000Source: Ibbotson Associates-60-40-20204060263354455556657758859952Common StocksLong T-BondsT-BillsYearPercentage Return8-9Suppose there are 5 possible outcomes over the investment horizon for the following securities:EconomyProb.T-BillHTCollUSRMPRecession0.15.5%-27.0%27.0% 6.0%-17.0%Below avg0.25.5%-7.0%13.0%-14.0%-3.0%Average0.45.5%15.0%0.0%3.0%10.0%Above avg0.25.5%30.0%-11.0%41.0%25.0%Boom0.15.5%45.0%-21.0%26.0%38.0%8-10Why is the T-bill return independent of the economy? T-bills will return the promised 5.5%, regardless of the economy....
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capm - 8-1CHAPTER 8Risk and Rates of ReturnThis chapter is...

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