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BUS 420 Chapter_02

# BUS 420 Chapter_02 - CHAPTER 2 CHAPTER Risk and Return Part...

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CHAPTER 2 CHAPTER 2 Risk and Return: Part I 1

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Focus Areas Focus Areas Basic return concepts Basic risk concepts Stand-alone risk Portfolio (market) risk Risk and return: CAPM/SML 2
What are investment returns? What are investment returns? (a) (a) Investment returns measure the financial results of an investment. Returns may be historical or prospective (anticipated). Returns can be expressed in: Dollar terms. Percentage terms. 3

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An investment costs \$1,000 and is sold An investment costs \$1,000 and is sold after 1 year for \$1,100. (a) after 1 year for \$1,100. (a) 4 Dollar return: Percentage return: \$ Received  -  \$ Invested     \$1,100      -   \$1,000       = \$100. \$ Return/\$ Invested       \$100/\$1,000        = 0.10 = 10%.
What is investment risk? What is investment risk? Typically, investment returns are not known with certainty. Investment risk pertains to the probability of earning a return less than that expected. The greater the chance of a return far below the expected return, the greater the risk. 5

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What is unique about the T-bill What is unique about the T-bill return? (b1 & 2) return? (b1 & 2) The T-bill will return 8% regardless of the state of the economy. Is the T-bill riskless? Explain. Alta Inds. and Repo Men vs. the Economy 6
Calculate the expected rate of Calculate the expected rate of return on each alternative. (c) return on each alternative. (c) 7 r = expected rate of return. r Alta  = 0.10(-22%) + 0.20(-2%)  + 0.40(20%) + 0.20(35%)  + 0.10(50%) = 17.4%. ^ ^ n r =    ^ i=1 r i P i .

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Alta has the highest rate of Alta has the highest rate of return. Does that make it best? return. Does that make it best? (c) (c) ^ r Alta 17.4% Market 15.0 Am. Foam 13.8 T-bill   8.0 Repo Men   1.7 8
What is the standard deviation What is the standard deviation of returns for each alternative? (d) of returns for each alternative? (d) 9 σ  = Standard deviation σ  =   Variance =    σ 2 n i=1 (r i  – r) 2  P i .

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