FIN CH 8

# FIN CH 8 - 1 PrinciplesofFinanceFIN3100 Chapter8 Risk and...

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Principles of Finance – FIN 3100 Chapter 8  – Risk and Return 1 Patty Robertson

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Agenda Calculate ROI and convert holding period returns into annual  returns. Define and understand risk. Appreciate the historical returns on various investments. Calculate standard deviations / variances with historical data. Calculate expected returns and variances with conditional returns  and probabilities. Interpret the trade-off between risk and return. Understand when and why diversification matters. Explain Beta as a measure of risk. 2
Abbreviations 3

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Returns Investors want to maximize returns and minimize  risk. This is called the  risk-and-return tradeoff , or  the ‘ability-to-sleep-at-night-test.’ In order to analyze investment performance, you  must know how to measure returns over time. 4
Return On Investment (ROI) After the fact, actual investment returns can be  measured by calculating the  Return On  Investment , or  ROI , an annual measure . The ROI includes: Income      Cash received. Capital Gain/Loss     The change in the value  of the asset. 5

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Dollar Profits & Percentage Returns Dollar Profit or Loss  =     Ending value    + Distributions  – Original Cost Rate of Return  Dollar Profit or Loss       Original Cost 6
Dollar ROI Stock Example You took a \$3,700 position in a stock. 100 shares @ \$37/share The stock paid a \$1.85/share dividend during the  year and is worth \$40.33 one year later. What is your ROI? Income: \$1.85 × 100 shares  = \$185 7

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Calculating Dollar ROI Your ROI includes the Capital Gain or Loss  regardless if you actually sold the security.   Whether or not you sell the security at the end of  the year is irrelevant. Realized income (losses)  is  relevant for tax  purposes. 8
Percentage ROI - Stock To compare investments, percentages are used. Percentages allow you to compare  relative   returns. Dividend Yield  D t +1 / P t Capital Gain/Loss Yield  (P t +1  -  P t ) / P t Total ROI  = [ (P t +1  -  P t ) + D t +1] / P t 9

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Percentage ROI Stock Example You took a \$3,700 position in a stock. 100 shares @ \$37.00/share \$1.85/share dividend; \$40.33/share one year later Dividend Yield =  D t +1 / P t = \$1.85/\$37.00 = .05 =  5% Capital Gain/Loss Yield =  (P t +1  -  P t ) / P t 10 For every \$1 invested, we got 5¢ in dividends and 9¢ in share appreciation. Together, we earned 14¢, or a 14% ROI.
ROI Bond Example You bought a bond for \$950 one year ago. You  have received two coupons of \$30 each. You  can sell the bond for \$975 today. What is your  total dollar return?  Percentage return?

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## This document was uploaded on 11/02/2011 for the course FIN 3100 at Kennesaw.

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FIN CH 8 - 1 PrinciplesofFinanceFIN3100 Chapter8 Risk and...

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