2 61 determine interest expense determine interest

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Unformatted text preview: C 31 After studying Chapter 5, you should be able to: 1. 2. 3. 4. 5. 6. 7. 8. 9. 63 Understand the relationship (or “trade-off”) between risk and return. Define risk and return and show how to measure them by calculating risk and return and show how to measure them by calculating expected return, standard deviation, and coefficient of variation. Discuss the different types of investor attitudes toward risk. Explain risk and return in a portfolio context, and distinguish between individual security and portfolio risk. Distinguish between avoidable (unsystematic) risk and unavoidable (systematic) risk and explain how proper diversification can eliminate one of these risks. Define and explain the capital-asset pricing model (CAPM), beta, and the characteristic line. Calculate a required rate of return using the capital-asset pricing model (CAPM). Demonstrate how the Security Market Line (SML) can be used to describe this relationship between expected rate of return and systematic risk. Explain what is meant by an “efficient financial market” and describe the three levels (or forms) of market efficiency. Certified Financial Controller CFC Risk and Return • • • • • • • 64 Defining Risk and Return Using Probability Distributions to Measure Risk Attitudes Toward Risk Risk and Return in a Portfolio Context Diversification The Capital Asset Pricing Model (CAPM) Efficient Financial Markets Certified Financial Controller CFC 32 Defining Return Income received on an investment Income received on an investment plus any change in market price price, usually expressed as a percent of the beginning market price of the investment. investment. R= 65 Dt + (Pt – Pt - 1 ) P Pt - 1 Certified Financial Controller CFC Return Example The stock price for Stock A was $10 per stock price for Stock was share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend. What return dividend was earned over the past year? 66 Certified Financial Controller CFC 33 Return Example The stock price for Stock A was $10 per stock price for Stock was share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend. What return dividend was earned over the past year? $1.00 + ($9.50 – $10.00 ) $ 10. = 5% R= $10.00 10. 67 Certified Financial Controller CFC Defining Risk The variability of returns from The variability of returns from those those that are expected. What rate of return do you expect on your investment (savings) this year? What rate will you actually earn? Does it matter if it is a bank CD or a share of stock? 68 Certified Financial Controller CFC 34 Determining Expected Return (Discrete Dist.) n R = Σ ( Ri )( Pi ) I=1 R is the expected return for the asset, Ri is the return for the ith possibility, Pi is the probability of that return th th occurring, n is the total number of possibilities. 69 Certified Financial Controller CFC How to Determine the Expected Return and Standard Deviation Stock BW BW Ri Pi (Ri)(Pi) -0.15 -0.03 0.09 0.21 0.33 –0.015 –0.006 0.036 0.042 0.033 Sum 70 0.10 0.20 0.40 0.20 0.10 1.00 0.090 Certified Financial Controller CFC 35 The expected return, R, for Stock BW is .09 or 9% Determining Standard Deviation (Risk Me...
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