Risk and Return.ppt
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1、,CHAPTER 3 Risk and Return,Basic return conceptsBasic risk conceptsStand-alone riskPortfolio (market) riskRisk and return: CAPM/SML,What are investment returns?,Investment returns measure the financial results of an investment.Returns may be historical or prospective (anticipated).Returns can be exp
2、ressed in:Dollar terms.Percentage terms.,What is the return on an investment that costs $1,000 and is soldafter 1 year for $1,100?,Dollar return:,Percentage return:,$ Received - $ Invested $1,100 - $1,000 = $100.,$ Return/$ Invested $100/$1,000 = 0.10 = 10%.,What is investment risk?,Typically, inves
3、tment 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.,Probability distribution,Rate ofreturn (%),50,15,0,-20,Stock X,Stock Y,Which stoc
4、k is riskier? Why?,Assume the FollowingInvestment Alternatives,What is unique about the T-bill return?,The T-bill will return 8% regardless of the state of the economy.Is the T-bill riskless? Explain.,Do the returns of HT and Collections move with or counter to the economy?,HT moves with the economy
5、, so it is positively correlated with the economy. This is the typical situation.Collections moves counter to the economy. Such negative correlation is unusual.,Calculate the expected rate of return on each alternative.,r = expected rate of return.,rHT = 0.10(-22%) + 0.20(-2%) + 0.40(20%) + 0.20(35%
6、) + 0.10(50%) = 17.4%.,HT has the highest rate of return. Does that make it best?,What is the standard deviationof returns for each alternative?,HT: = (-22 - 17.4)20.10 + (-2 - 17.4)20.20 + (20 - 17.4)20.40 + (35 - 17.4)20.20 + (50 - 17.4)20.10)1/2 = 20.0%.,Prob.,Rate of Return (%),T-bill,USR,HT,0,8
7、,13.8,17.4,Standard deviation measures the stand-alone risk of an investment.The larger the standard deviation, the higher the probability that returns will be far below the expected return.Coefficient of variation is an alternative measure of stand-alone risk.,Expected Return versus Risk,Coefficien
8、t of Variation:CV = Expected return/standard deviation.,CVT-BILLS = 0.0%/8.0% = 0.0.CVHIGH TECH = 20.0%/17.4%= 1.1.CVCOLLECTIONS= 13.4%/1.7%= 7.9.CVU.S. RUBBER= 18.8%/13.8%= 1.4.CVM = 15.3%/15.0%= 1.0.,Expected Return versus Coefficient of Variation,Return vs. Risk (Std. Dev.): Which investment is b
9、est?,Portfolio Risk and Return,Assume a two-stock portfolio with $50,000 in HT and $50,000 in Collections.,Calculate rp and p.,Portfolio Return, rp,rp is a weighted average:,rp = 0.5(17.4%) + 0.5(1.7%) = 9.6%.,rp is between rHT and rColl.,rp = wiri,n,i = 1,Alternative Method,rp = (3.0%)0.10 + (6.4%)
10、0.20 + (10.0%)0.40 + (12.5%)0.20 + (15.0%)0.10 = 9.6%.,Estimated Return,(More.),p = (3.0 - 9.6)20.10 + (6.4 - 9.6)20.20 + (10.0 - 9.6)20.40 + (12.5 - 9.6)20.20 + (15.0 - 9.6)20.10)1/2 = 3.3%.p is much lower than:either stock (20% and 13.4%).average of HT and Coll (16.7%).The portfolio provides avera
11、ge return but much lower risk. The key here is negative correlation.,Two-Stock Portfolios,Two stocks can be combined to form a riskless portfolio if r = -1.0.Risk is not reduced at all if the two stocks have r = +1.0. In general, stocks have r 0.65, so risk is lowered but not eliminated.Investors ty
12、pically hold many stocks.What happens when r = 0?,What would happen to therisk of an average 1-stockportfolio as more randomlyselected stocks were added?,p would decrease because the added stocks would not be perfectly correlated, but rp would remain relatively constant.,Large,0,15,Prob.,2,1,1 35% ;
13、 Large 20%.,Return,# Stocks in Portfolio,102030 40 2,000+,Company Specific (Diversifiable) Risk,Market Risk,20 0,Stand-Alone Risk, p,p (%),35,Stand-alone Market Diversifiable,Market risk is that part of a securitys stand-alone risk that cannot be eliminated by diversification.Firm-specific, or diver
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