Risk and Return - Chapter 6 Risk and return 1 Table of...

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Chapter 6 Risk and return 1
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Table of Contents 1. Overview 2. Historical rates of return 2.1 Bank accepted bills (BABs) 2.2 10 year government bonds 2.3 Shares in listed companies 2.4 Return performances of all asset types 3. Measuring risk from investing in single securities 3.1 Calculation of risk using a historical time series of returns 3.2 Calculation of risk using subjective probabilities 4. The risk of portfolios 4.1 Covariance 4.2 Correlation coefficient 5. Calculating the risk of portfolios 6. Components of risk 6.1 Unsystematic risk 6.2 Systematic risk 7. Measurement of the components of total risk 2
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So far we have discussed the valuing of assets with certain future cash flows What if there is some element of risk is attached to the future payoff? The investor would require a higher rate of return as a compensation in order to buy the asset with risky future cash. More formally, the investor adds a risk premium to the guaranteed, or risk free , rate: 1. Overview Required rate of return % risk free rate % risk premium % (6.1) 3
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Table of Contents 1. Overview 2. Historical rates of return 2.1 Bank accepted bills (BABs) 2.2 10 year government bonds 2.3 Shares in listed companies 2.4 Return performances of all asset types 3. Measuring risk from investing in single securities 3.1 Calculation of risk using a historical time series of returns 3.2 Calculation of risk using subjective probabilities 4. The risk of portfolios 4.1 Covariance 4.2 Correlation coefficient 5. Calculating the risk of portfolios 6. Components of risk 6.1 Unsystematic risk 6.2 Systematic risk 7. Measurement of the components of total risk 4
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2. Historical rates of return Past return movements may give some indications of future returns E.g. Repeating trends We will look at historical returns on: Debt instruments Short term: 90 day Bank accepted bills Long term: 10 year government bonds Shares in listed Australian companies (stocks) 5
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Bank accepted bills (BABs) Are short term debt securities issued by a borrowing corporation Payment is guaranteed by a bank (the bank pays the investor at maturity) Marketed by the borrowing corporation directly or by the bank 2.1 Bank accepted bills (BABs) 6
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Characteristics of BABs Uncollateralized but considered default risk free if accepting bank is a major bank Typical maturity of up to 180 days Typical minimum amount is $500,000 ‘zero coupon’ or discounted securities No interim interest payment BABs are sold at a discount and full FV paid at maturity The difference between FV and discounted price is the total return on investment 2.1 Bank accepted bills (BABs) 7
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where: V=c u r r e n t value of a bank accepted bill t= t h e time to maturity in days i= y i e l d p.a. (nominal with compounding period equal to the BAB maturity period) 365 1 000 , 500 t i V (6.3) 2.1 Bank accepted bills (BABs) 8
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Example,i= 5%pa, FV = $500,000 Interest earned over the 90 day period is $6,089.31 69 . 910 , 493 $ 365 90 05 . 0 1 000 , 500 V 2.1 Bank accepted bills (BABs) 9
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Risk and Return - Chapter 6 Risk and return 1 Table of...

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