Sources of Risk•Event Risk:occurs when an unexpected event has a significant and unusually immediate effect on the underlying value of an investment.•Market Risk:the risk that investment returns will decline because of factors that affect the broader market, not just one company or one investment.◦Examples: political, economic, and social events as well as changes in investor tastes and preferences◦Actually embodies a number of risks including purchasing power risk, interest rate risk, and tax risk.

Risk: The Other Side of the Coin
Risk of a Single Asset
•
Standard Deviation: An Absolute Measure of Risk
◦
Standard Deviation:
An indicator of an asset’s risk, it measure the dispersion
(variation) of returns around an asset’s average or expected return.

Table 4.8 Historical Annual Returns for Target and American Eagle OutfittersHow much do these returns deviate from the average?

Standard Deviations Graphical Representation
High standard deviation means
results more far away from the
average are more probable…

Standard Deviations Graphical Representation
AAPL vs. S&P500 index

Table 4.9
Calculation of Standard Deviations of Returns for Target and
American Eagle Outfitters (1 of 2)

Table 4.9
Calculation of Standard Deviations of Returns for Target and
American Eagle Outfitters (2 of 2)

Risk: The Other Side of the Coin
Risk of a Single Asset
•
Historical Returns and Risk
◦
Standard deviation can be used as a measure of risk to
assess historical investment return data
◦
General pattern:
Investments with higher average returns
have higher standard deviations, reflecting greater risk.

Table 4.10 Historical Returns and Standard Deviations for Select Asset Classes (1900–2014)Are higher returns always associated with more risk?

Risk: The Other Side of the Coin
Assessing Risk
•
A look at the general risk-return characteristics of alternative
investments and at the question of an acceptable level of
risk helps show how to evaluate risk.
•
Risk-Return Characteristics of Alternative Investments
◦
A risk-return tradeoff exists such that for a higher risk one expects a higher return,
and vice versa.
◦
In general, low-risk/low-return investments include U.S. government securities and
deposit accounts.
◦
In general, high-risk/high-return investments include real estate and other tangible
investments, common stocks, options, and futures.

Risk-Return Tradeoffs for Various Investments

Figure 4.3
Risk Preferences