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 “tradeoff”) 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 capitalasset pricing model (CAPM), beta, and the
characteristic line.
Calculate a required rate of return using the capitalasset 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
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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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This note was uploaded on 05/28/2013 for the course FINANCE economy taught by Professor Nill during the Fall '12 term at Bronx School Of Law And Finance.
 Fall '12
 nill
 Time Value Of Money

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