This document discusses risk and return, including key concepts such as:
- Risk is defined as the potential variability in investment returns, while return refers to the total gain or loss on an investment.
- There is typically a relationship between higher risk and higher potential returns.
- Standard deviation and beta are common measures used to quantify investment risk. Beta specifically measures the volatility of a security compared to the overall market.
- Portfolio risk can be reduced through diversification among assets with low or negative correlations. However, some systematic market risk cannot be diversified away.
- The Capital Asset Pricing Model (CAPM) describes the expected return of an asset based on its beta and the expected market return.
1) Total risk of a security is composed of systematic risk, which stems from external market factors, and unsystematic risk, which is specific to a company.
2) Diversifying a portfolio by holding many securities with returns that are not perfectly positively correlated can reduce total risk through lowering unsystematic risk exposure.
3) The degree of risk reduction from diversification depends on the correlation between the returns of the securities in the portfolio. Perfectly negatively correlated securities eliminate risk, while perfectly positively correlated securities do not allow for risk reduction through diversification.
Managerial Finance. "Risk and Return". Types of risk. Required return. Correlation. Diversification. Beta coefficient. Risk of a portfolio. Capital Asset Pricing Model. Security Market Line.
The document discusses risk and return related to financial assets. It defines return as the total gain from an asset including price changes and cash payments. Risk is the variability between actual and expected returns, with greater chances of loss seen as riskier. Managers have different risk preferences such as being risk indifferent, risk averse, or risk seeking. Risk is computed using methods like standard deviation, which measures dispersion around the expected return. There are systematic risks that influence many assets, like interest rates, and unsystematic risks that are specific to individual assets. Diversification reduces unsystematic risk. The capital asset pricing model relates risk premium to an asset's beta, or systematic risk relative to the market.
- The chapter discusses portfolio theory and models for determining asset prices like the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT).
- Portfolio risk depends on the correlation and covariance of returns between assets. Diversification reduces unsystematic risk but not systematic market risk.
- CAPM suggests investors should hold a combination of the risk-free asset and the market portfolio. It provides a framework to determine required rates of return based on an asset's systematic risk or beta.
- APT assumes asset returns have predictable and unpredictable components related to macroeconomic factors. It provides an alternative model to CAPM for determining expected returns.
The document discusses how portfolio risk is reduced through diversification by combining assets that have returns affected in opposite directions by changes in economic variables. It provides an example where investing in two stocks, PIA and POL, reduces risk compared to investing in just one. While the average return of a portfolio is a weighted average, the risk is lower because negative impacts on one asset from economic changes are offset by positive impacts on the other asset. The covariance and correlation coefficient between assets are used to calculate the risk of the combined portfolio. Lower covariance means returns move in opposite directions, reducing overall risk more than assets with high positive covariance that move in the same direction.
The document discusses the relationship between risk and return, known as the risk-return nexus. It defines key concepts like risk, return, systematic and unsystematic risk. It explains that total risk is comprised of systematic and unsystematic risk, but that unsystematic risk can be diversified away. The Capital Asset Pricing Model (CAPM) asserts that the expected return of an asset depends only on its systematic risk. Empirical analysis of CAPM shows strong correlation between market returns and the returns of various bonds, supporting the model.
This document discusses the relationship between risk and return in investments. It defines total risk as the sum of systematic and unsystematic risk. Systematic risk stems from external market factors that affect all investments, while unsystematic risk is specific to a particular company. The expected return and risk of individual stocks varies, with higher risk investments generally offering higher returns. A portfolio combines multiple assets to reduce overall risk through diversification. The portfolio risk depends on the covariance and correlation between the individual assets' returns. Diversifying across assets with low correlation is an effective way to reduce risk.
Risk and Return Analysis .ppt By Sumon SheikhSumon Sheikh
Risk and return analysis presentation with suitable examples. A perfect class-presentation file.
Prepared by Sumon Sheikh, BBA Student, majoring Accounting and Information Systems at Jatiya Kabi Kazi Nazrul Islam University, Trishal, Mymensingh-2224, Bangladesh.
1) Total risk of a security is composed of systematic risk, which stems from external market factors, and unsystematic risk, which is specific to a company.
2) Diversifying a portfolio by holding many securities with returns that are not perfectly positively correlated can reduce total risk through lowering unsystematic risk exposure.
3) The degree of risk reduction from diversification depends on the correlation between the returns of the securities in the portfolio. Perfectly negatively correlated securities eliminate risk, while perfectly positively correlated securities do not allow for risk reduction through diversification.
Managerial Finance. "Risk and Return". Types of risk. Required return. Correlation. Diversification. Beta coefficient. Risk of a portfolio. Capital Asset Pricing Model. Security Market Line.
The document discusses risk and return related to financial assets. It defines return as the total gain from an asset including price changes and cash payments. Risk is the variability between actual and expected returns, with greater chances of loss seen as riskier. Managers have different risk preferences such as being risk indifferent, risk averse, or risk seeking. Risk is computed using methods like standard deviation, which measures dispersion around the expected return. There are systematic risks that influence many assets, like interest rates, and unsystematic risks that are specific to individual assets. Diversification reduces unsystematic risk. The capital asset pricing model relates risk premium to an asset's beta, or systematic risk relative to the market.
- The chapter discusses portfolio theory and models for determining asset prices like the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT).
- Portfolio risk depends on the correlation and covariance of returns between assets. Diversification reduces unsystematic risk but not systematic market risk.
- CAPM suggests investors should hold a combination of the risk-free asset and the market portfolio. It provides a framework to determine required rates of return based on an asset's systematic risk or beta.
- APT assumes asset returns have predictable and unpredictable components related to macroeconomic factors. It provides an alternative model to CAPM for determining expected returns.
The document discusses how portfolio risk is reduced through diversification by combining assets that have returns affected in opposite directions by changes in economic variables. It provides an example where investing in two stocks, PIA and POL, reduces risk compared to investing in just one. While the average return of a portfolio is a weighted average, the risk is lower because negative impacts on one asset from economic changes are offset by positive impacts on the other asset. The covariance and correlation coefficient between assets are used to calculate the risk of the combined portfolio. Lower covariance means returns move in opposite directions, reducing overall risk more than assets with high positive covariance that move in the same direction.
The document discusses the relationship between risk and return, known as the risk-return nexus. It defines key concepts like risk, return, systematic and unsystematic risk. It explains that total risk is comprised of systematic and unsystematic risk, but that unsystematic risk can be diversified away. The Capital Asset Pricing Model (CAPM) asserts that the expected return of an asset depends only on its systematic risk. Empirical analysis of CAPM shows strong correlation between market returns and the returns of various bonds, supporting the model.
This document discusses the relationship between risk and return in investments. It defines total risk as the sum of systematic and unsystematic risk. Systematic risk stems from external market factors that affect all investments, while unsystematic risk is specific to a particular company. The expected return and risk of individual stocks varies, with higher risk investments generally offering higher returns. A portfolio combines multiple assets to reduce overall risk through diversification. The portfolio risk depends on the covariance and correlation between the individual assets' returns. Diversifying across assets with low correlation is an effective way to reduce risk.
Risk and Return Analysis .ppt By Sumon SheikhSumon Sheikh
Risk and return analysis presentation with suitable examples. A perfect class-presentation file.
Prepared by Sumon Sheikh, BBA Student, majoring Accounting and Information Systems at Jatiya Kabi Kazi Nazrul Islam University, Trishal, Mymensingh-2224, Bangladesh.
This chapter discusses portfolio risk and return. It introduces the concept that investors should care about systematic risk rather than total risk, as total risk can be reduced through diversification while systematic risk cannot. It outlines how modern portfolio theory uses beta to measure the sensitivity of an asset to market movements, representing systematic risk. The chapter also discusses how diversification reduces nonsystematic or idiosyncratic risk but not market risk, and how portfolio risk decreases as the number of assets in the portfolio increases, up to a certain point.
The document discusses key statistical terms used in analyzing portfolio performance including mean, standard deviation, variance, correlation coefficient, and normal distribution. It explains how mean measures average returns, variance and standard deviation measure risk/volatility, and correlation measures the relationship between two investments. The document also covers portfolio theory, the efficient frontier, and risk/return analysis tools like the Sharpe Ratio and Value at Risk (VAR) that are used to evaluate portfolio performance based on expected return and risk.
Risk and Return
-risk and uncertainty
-differences and similarities between risk and uncertainty
-types of risk (systematic and unsystematic)
-why manages risk? and its scope in finance.
-CAPM and its problem
-return
This document discusses risk and return relationships in investment and portfolio management. It covers key concepts such as:
- The relationship between risk and expected return of individual assets. Higher risk is generally associated with higher expected returns.
- How portfolio risk and return are calculated based on the individual assets within the portfolio, their weights, and the covariance between the assets. A portfolio's risk can be lower than the risks of individual assets due to diversification.
- Important portfolio theory concepts like the efficient frontier and capital market line that show the tradeoff between risk and return for efficient portfolios.
The document discusses risk and return in investments. It defines key concepts such as realized and expected return, ex-ante and ex-post returns, sources and measurements of risk including standard deviation and coefficient of variation. It also discusses the risk-return tradeoff and how higher risk investments require higher potential returns to compensate for additional risk.
This document provides an overview of key topics in risk analysis, including definitions of risk and uncertainty, general categories of risk, methods of measuring risk such as probability distributions and expected value, and approaches to decision-making under risk and uncertainty. It discusses concepts like risk attitudes, utility theory, certainty equivalents, and decision rules from game theory like maximin and minimax regret. The goal is to help decision makers understand risk and make effective investment decisions.
The document discusses risk and rates of return, including stand-alone risk, portfolio risk, and the Capital Asset Pricing Model. It defines risk as the chance of an unfavorable outcome and discusses how risk is measured using concepts like standard deviation, beta, and the capital market line. Diversification across many assets or asset classes can reduce risk for a portfolio, though not below the market risk.
The Markowitz Model assists investors in selecting efficient portfolios by analyzing possible combinations of securities. It helps reduce risk through diversification by choosing securities whose price movements are not perfectly correlated. The model determines the efficient set of portfolios and allows investors to select the optimal portfolio based on their preferred risk-return tradeoff. Markowitz introduced diversification and showed holding multiple lower-risk securities can reduce overall portfolio risk compared to a single higher-risk security. The model calculates expected returns, variances, and correlations between securities to determine the minimum risk portfolio for a given level of return.
Investing in a single asset carries unique risks based on the variability and standard deviation of that asset's historical returns. Diversifying among multiple unrelated assets reduces overall portfolio risk, as poor performance of some assets may be offset by positive returns from others. While any single asset could fail, it is less likely that all assets in a portfolio would fail at the same time by experiencing losses. Therefore, diversification helps stabilize returns and lower risk compared to investing in only a single asset.
The document discusses risk and return in investing. It explains that equity investments like stocks historically have higher average returns of over 10% compared to debt investments like bonds that return 3-4%, but stocks are also more volatile. It defines risk as the variability of returns, and introduces the concepts of systematic risk that affects all stocks equally and unsystematic risk that is specific to individual stocks. Diversification can reduce unsystematic risk but not systematic risk. It also discusses measuring market risk through a stock's beta value, which represents its volatility relative to the overall market.
This document discusses portfolio risk and return, including expected return, measures of risk like variance and standard deviation, and how diversification can reduce risk. It provides examples of calculating expected return, variance, and standard deviation for individual stocks and portfolios. It then introduces the Capital Asset Pricing Model (CAPM), which specifies the relationship between risk and required return of individual stocks based on the stock's beta. It provides examples of using the CAPM equation to calculate required return given beta and market factors, and calculating beta given expected return and market factors.
The document discusses probability-based approaches for calculating expected returns and variance under uncertainty. It provides an example using return data for a stock to calculate the expected return of 9.25% and variance of 0.02%. It also discusses how portfolio return and variance depends on asset weights, the individual asset expected returns and variances, and the correlation between the assets. Assuming the two example assets are perfectly negatively correlated, it calculates the asset weights needed for a zero risk portfolio and the expected return of that portfolio as 25.36%. Finally, it discusses limits to diversification in practice, such as the inability to hold all securities and that only unsystematic risk can be reduced through diversification.
- Peter Lynch purchased 100 shares of Iomega Corp. 3 months ago at $50 per share. He received $0.25 dividends per share last month. The shares are now worth $56 each.
- The document discusses concepts related to risk and return such as random variables, probability, moments, variance, standard deviation, and covariance. It provides an example of computing these statistics for two companies.
- Portfolio theory holds that combining securities reduces risk through diversification. The correlation between securities also impacts the risk of a portfolio. The portfolio with the highest expected return for a given level of risk makes up the efficient frontier.
This document discusses risk and return as key determinants of share price that financial managers must assess. It defines risk as the potential variability in returns and discusses different types of risk in financing and investment decisions. Return is defined as the realizable cash flow from an investment. The document also discusses how to measure risk through variability of returns, using variance and standard deviation, as well as how to calculate expected return and risk by incorporating probabilities into estimates.
Financial Management: Risk and Rates of Returnpetch243
This document discusses risk and rates of return in investments. It defines different types of risk like stand-alone risk and portfolio risk. It shows how to calculate expected returns, standard deviation as a measure of risk, and the coefficient of variation to compare risk-adjusted returns. It introduces the Capital Asset Pricing Model (CAPM) and how it uses beta to measure non-diversifiable market risk and determine required rates of return based on the security market line. It provides examples of calculating betas, expected returns, and portfolio risk measures like standard deviation and required returns.
Business Finance Chapter 11 Risk and returnTinku Kumar
This chapter discusses predicting stock market returns and measuring risk. It introduces expected returns and standard deviation as measures of average return and risk. It then discusses how new, unexpected information can impact stock prices and returns. It also introduces beta as a measure of a stock's systematic, market risk. The chapter concludes by discussing the security market line and capital asset pricing model, which relate expected return and risk by establishing the market risk premium.
Measurement of Risk and Calculation of Portfolio RiskDhrumil Shah
This document discusses measuring risk and calculating portfolio risk. It defines risk as the probability of loss and explains that higher investment means higher risk but also higher potential return. It then discusses measuring the risk of individual assets using variance and standard deviation calculated from the asset's probability distribution of returns. The document also explains how to calculate the expected return, variance and standard deviation of a portfolio by taking the weighted average of the individual assets. Diversifying a portfolio can reduce overall risk since the returns on different assets may not move in the same direction.
This document discusses various methods for evaluating portfolio performance, including risk-adjusted measures based on the Capital Asset Pricing Model (CAPM) like the Jensen Index, Treynor Index, and Sharpe Index. It also addresses limitations of CAPM measures when borrowing and lending assumptions don't hold or when the market index is inefficient. Performance measures based on the Arbitrage Pricing Theory are also examined.
1) Return is the income received from an investment plus any change in the market price expressed as a percentage of the beginning market price. It measures the profit or loss over a period of time.
2) Risk is the variability of returns compared to expected returns. Higher variability means higher risk. Standard deviation is commonly used to measure the risk of an investment.
3) Portfolio expected return is calculated by weighting the expected return of each individual asset by its proportion in the portfolio. Portfolio risk is measured by standard deviation which takes into account the covariances between assets. Diversification reduces unsystematic risk.
This document summarizes key concepts from Chapter 5 of Principles of Managerial Finance by Lawrence J. Gitman, which focuses on risk and return. It discusses measuring risk for single and multiple assets, the benefits of diversification, and international diversification. It then introduces the Capital Asset Pricing Model (CAPM) as a tool for valuing securities based on their non-diversifiable risk relative to the market. The chapter materials include study guides, problem templates, and answers to review questions about risk measurement, diversification, beta calculation, and the security market line.
Risk and return are key concepts in finance. Return represents the total gain or loss on an investment. Risk is the potential variability in future cash flows and the possibility that actual returns will differ from expected returns. Expected return is the return an investor expects to earn on an asset, while required return is the return an investor requires given an asset's risk. Standard deviation and coefficient of variation are common measures of risk. A portfolio combines multiple assets to reduce overall risk through diversification. The two main types of risk are unsystematic (company-specific) risk, which can be diversified away, and systematic (market) risk, which cannot. Beta is used to measure an asset's systematic risk relative to the market.
The document discusses various concepts related to risk and rates of return on investments. It defines different types of risk like stand-alone risk and portfolio risk. It also introduces the Capital Asset Pricing Model (CAPM) which relates a security's expected return to its risk compared to the overall market. The CAPM graphs expected returns against risks using the Security Market Line and shows how diversification reduces risk for a portfolio.
This chapter discusses portfolio risk and return. It introduces the concept that investors should care about systematic risk rather than total risk, as total risk can be reduced through diversification while systematic risk cannot. It outlines how modern portfolio theory uses beta to measure the sensitivity of an asset to market movements, representing systematic risk. The chapter also discusses how diversification reduces nonsystematic or idiosyncratic risk but not market risk, and how portfolio risk decreases as the number of assets in the portfolio increases, up to a certain point.
The document discusses key statistical terms used in analyzing portfolio performance including mean, standard deviation, variance, correlation coefficient, and normal distribution. It explains how mean measures average returns, variance and standard deviation measure risk/volatility, and correlation measures the relationship between two investments. The document also covers portfolio theory, the efficient frontier, and risk/return analysis tools like the Sharpe Ratio and Value at Risk (VAR) that are used to evaluate portfolio performance based on expected return and risk.
Risk and Return
-risk and uncertainty
-differences and similarities between risk and uncertainty
-types of risk (systematic and unsystematic)
-why manages risk? and its scope in finance.
-CAPM and its problem
-return
This document discusses risk and return relationships in investment and portfolio management. It covers key concepts such as:
- The relationship between risk and expected return of individual assets. Higher risk is generally associated with higher expected returns.
- How portfolio risk and return are calculated based on the individual assets within the portfolio, their weights, and the covariance between the assets. A portfolio's risk can be lower than the risks of individual assets due to diversification.
- Important portfolio theory concepts like the efficient frontier and capital market line that show the tradeoff between risk and return for efficient portfolios.
The document discusses risk and return in investments. It defines key concepts such as realized and expected return, ex-ante and ex-post returns, sources and measurements of risk including standard deviation and coefficient of variation. It also discusses the risk-return tradeoff and how higher risk investments require higher potential returns to compensate for additional risk.
This document provides an overview of key topics in risk analysis, including definitions of risk and uncertainty, general categories of risk, methods of measuring risk such as probability distributions and expected value, and approaches to decision-making under risk and uncertainty. It discusses concepts like risk attitudes, utility theory, certainty equivalents, and decision rules from game theory like maximin and minimax regret. The goal is to help decision makers understand risk and make effective investment decisions.
The document discusses risk and rates of return, including stand-alone risk, portfolio risk, and the Capital Asset Pricing Model. It defines risk as the chance of an unfavorable outcome and discusses how risk is measured using concepts like standard deviation, beta, and the capital market line. Diversification across many assets or asset classes can reduce risk for a portfolio, though not below the market risk.
The Markowitz Model assists investors in selecting efficient portfolios by analyzing possible combinations of securities. It helps reduce risk through diversification by choosing securities whose price movements are not perfectly correlated. The model determines the efficient set of portfolios and allows investors to select the optimal portfolio based on their preferred risk-return tradeoff. Markowitz introduced diversification and showed holding multiple lower-risk securities can reduce overall portfolio risk compared to a single higher-risk security. The model calculates expected returns, variances, and correlations between securities to determine the minimum risk portfolio for a given level of return.
Investing in a single asset carries unique risks based on the variability and standard deviation of that asset's historical returns. Diversifying among multiple unrelated assets reduces overall portfolio risk, as poor performance of some assets may be offset by positive returns from others. While any single asset could fail, it is less likely that all assets in a portfolio would fail at the same time by experiencing losses. Therefore, diversification helps stabilize returns and lower risk compared to investing in only a single asset.
The document discusses risk and return in investing. It explains that equity investments like stocks historically have higher average returns of over 10% compared to debt investments like bonds that return 3-4%, but stocks are also more volatile. It defines risk as the variability of returns, and introduces the concepts of systematic risk that affects all stocks equally and unsystematic risk that is specific to individual stocks. Diversification can reduce unsystematic risk but not systematic risk. It also discusses measuring market risk through a stock's beta value, which represents its volatility relative to the overall market.
This document discusses portfolio risk and return, including expected return, measures of risk like variance and standard deviation, and how diversification can reduce risk. It provides examples of calculating expected return, variance, and standard deviation for individual stocks and portfolios. It then introduces the Capital Asset Pricing Model (CAPM), which specifies the relationship between risk and required return of individual stocks based on the stock's beta. It provides examples of using the CAPM equation to calculate required return given beta and market factors, and calculating beta given expected return and market factors.
The document discusses probability-based approaches for calculating expected returns and variance under uncertainty. It provides an example using return data for a stock to calculate the expected return of 9.25% and variance of 0.02%. It also discusses how portfolio return and variance depends on asset weights, the individual asset expected returns and variances, and the correlation between the assets. Assuming the two example assets are perfectly negatively correlated, it calculates the asset weights needed for a zero risk portfolio and the expected return of that portfolio as 25.36%. Finally, it discusses limits to diversification in practice, such as the inability to hold all securities and that only unsystematic risk can be reduced through diversification.
- Peter Lynch purchased 100 shares of Iomega Corp. 3 months ago at $50 per share. He received $0.25 dividends per share last month. The shares are now worth $56 each.
- The document discusses concepts related to risk and return such as random variables, probability, moments, variance, standard deviation, and covariance. It provides an example of computing these statistics for two companies.
- Portfolio theory holds that combining securities reduces risk through diversification. The correlation between securities also impacts the risk of a portfolio. The portfolio with the highest expected return for a given level of risk makes up the efficient frontier.
This document discusses risk and return as key determinants of share price that financial managers must assess. It defines risk as the potential variability in returns and discusses different types of risk in financing and investment decisions. Return is defined as the realizable cash flow from an investment. The document also discusses how to measure risk through variability of returns, using variance and standard deviation, as well as how to calculate expected return and risk by incorporating probabilities into estimates.
Financial Management: Risk and Rates of Returnpetch243
This document discusses risk and rates of return in investments. It defines different types of risk like stand-alone risk and portfolio risk. It shows how to calculate expected returns, standard deviation as a measure of risk, and the coefficient of variation to compare risk-adjusted returns. It introduces the Capital Asset Pricing Model (CAPM) and how it uses beta to measure non-diversifiable market risk and determine required rates of return based on the security market line. It provides examples of calculating betas, expected returns, and portfolio risk measures like standard deviation and required returns.
Business Finance Chapter 11 Risk and returnTinku Kumar
This chapter discusses predicting stock market returns and measuring risk. It introduces expected returns and standard deviation as measures of average return and risk. It then discusses how new, unexpected information can impact stock prices and returns. It also introduces beta as a measure of a stock's systematic, market risk. The chapter concludes by discussing the security market line and capital asset pricing model, which relate expected return and risk by establishing the market risk premium.
Measurement of Risk and Calculation of Portfolio RiskDhrumil Shah
This document discusses measuring risk and calculating portfolio risk. It defines risk as the probability of loss and explains that higher investment means higher risk but also higher potential return. It then discusses measuring the risk of individual assets using variance and standard deviation calculated from the asset's probability distribution of returns. The document also explains how to calculate the expected return, variance and standard deviation of a portfolio by taking the weighted average of the individual assets. Diversifying a portfolio can reduce overall risk since the returns on different assets may not move in the same direction.
This document discusses various methods for evaluating portfolio performance, including risk-adjusted measures based on the Capital Asset Pricing Model (CAPM) like the Jensen Index, Treynor Index, and Sharpe Index. It also addresses limitations of CAPM measures when borrowing and lending assumptions don't hold or when the market index is inefficient. Performance measures based on the Arbitrage Pricing Theory are also examined.
1) Return is the income received from an investment plus any change in the market price expressed as a percentage of the beginning market price. It measures the profit or loss over a period of time.
2) Risk is the variability of returns compared to expected returns. Higher variability means higher risk. Standard deviation is commonly used to measure the risk of an investment.
3) Portfolio expected return is calculated by weighting the expected return of each individual asset by its proportion in the portfolio. Portfolio risk is measured by standard deviation which takes into account the covariances between assets. Diversification reduces unsystematic risk.
This document summarizes key concepts from Chapter 5 of Principles of Managerial Finance by Lawrence J. Gitman, which focuses on risk and return. It discusses measuring risk for single and multiple assets, the benefits of diversification, and international diversification. It then introduces the Capital Asset Pricing Model (CAPM) as a tool for valuing securities based on their non-diversifiable risk relative to the market. The chapter materials include study guides, problem templates, and answers to review questions about risk measurement, diversification, beta calculation, and the security market line.
Risk and return are key concepts in finance. Return represents the total gain or loss on an investment. Risk is the potential variability in future cash flows and the possibility that actual returns will differ from expected returns. Expected return is the return an investor expects to earn on an asset, while required return is the return an investor requires given an asset's risk. Standard deviation and coefficient of variation are common measures of risk. A portfolio combines multiple assets to reduce overall risk through diversification. The two main types of risk are unsystematic (company-specific) risk, which can be diversified away, and systematic (market) risk, which cannot. Beta is used to measure an asset's systematic risk relative to the market.
The document discusses various concepts related to risk and rates of return on investments. It defines different types of risk like stand-alone risk and portfolio risk. It also introduces the Capital Asset Pricing Model (CAPM) which relates a security's expected return to its risk compared to the overall market. The CAPM graphs expected returns against risks using the Security Market Line and shows how diversification reduces risk for a portfolio.
This document defines key concepts related to risk and return in investments. It discusses components of return including yields and capital gains. It also defines expected return, relative return, and real rate of return. The document outlines several types of risk that can impact investments such as market risk, interest rate risk, liquidity risk, and foreign exchange risk. It also discusses standard deviation and the coefficient of variation as measures of risk. Finally, the capital asset pricing model is introduced as relating expected return on an asset to its systematic risk.
The document provides an overview of key concepts related to expected returns, risk, and the security market line. It defines expected returns and how they differ from realized returns. It also discusses diversification and how it relates to systematic and unsystematic risk. The security market line models the relationship between risk and return, with the slope representing the market risk premium. The capital asset pricing model uses an asset's beta to determine its expected return based on the risk-free rate and market risk premium.
This document defines key concepts related to investment returns including yield, capital gains, total return, expected return, relative return, real/inflation-adjusted return, and risk. It discusses components of return including yield and capital gains. Total return is defined as the sum of yield and price change. Expected return is the weighted average of possible returns based on their probabilities. Relative return compares an investment's return to a benchmark. Real return removes the effects of inflation from the nominal return. Risk is defined as the variability between expected and actual returns, and various types of risk are described such as market risk and liquidity risk. Methods for analyzing risk including sensitivity analysis, standard deviation, and coefficient of variation are also summarized.
The document discusses key concepts in risk management and portfolio theory, including:
1) It defines risk as the variability of returns from expected returns, and return as the income and capital gains from an investment.
2) It explains how to calculate the expected return of a portfolio by weighting the expected returns of individual assets by their weights in the portfolio.
3) It discusses how diversification and the correlation between assets can help reduce overall risk. The total risk of a portfolio is made up of systematic risk, which affects all assets, and diversifiable or unsystematic risk.
4) It introduces the Capital Asset Pricing Model and the security market line, which describe the relationship between risk and expected
Return is the amount of gain or loss of an Investment for a particular period of time.
The future is uncertain. When we are dealing with the future, we assign probabilities to future returns. The Expected rate of return on an investment represents the mean probability distribution of possible future returns.
Risk reflects the chance that the actual return on an investment may be different than the expected return.
One way to measure risk is to calculate the variance and standard deviation of the distribution of returns.
We will once again use a probability distribution in our calculations.
This document discusses various methods of measuring risk, including variance, standard deviation, skewness, kurtosis, and the components of risk such as project-specific risk, competitive risk, industry risk, market risk, and international risk. It then discusses the capital asset pricing model (CAPM) and how it uses beta to measure non-diversifiable risk and translate that into an expected return. The document provides an example of estimating beta for Disney stock.
The Capital Asset Pricing Model (CAPM) formalizes the relationship between risk and expected return. It states that the expected return of an asset is determined by its sensitivity to non-diversifiable or systematic risk as measured by its beta. Beta measures how an asset's returns co-vary with the market portfolio. According to CAPM, an asset's expected return is equal to the risk-free rate plus its beta multiplied by the market risk premium. Diversification reduces risk by eliminating asset-specific or diversifiable risk, but not market risk.
1) The document discusses risk-return analysis and the efficient frontier. It introduces the Capital Market Line (CML), which shows superior portfolio combinations when investing in both risky and risk-free assets.
2) The CML is tangent to the efficient frontier at the market portfolio, which offers the highest Sharpe Ratio. The Sharpe Ratio represents excess return per unit of risk.
3) With access to risk-free borrowing and lending, investors are no longer confined to the efficient frontier, but can choose portfolios along the CML based on their individual risk preferences.
Portfolio management UNIT FIVE BBS 4th year by Dilli BaralDilliBaral
Unit 4 discusses return and risk, while Unit 5 covers modern portfolio theory. Portfolio theory holds that investing in multiple assets lowers overall risk if profits from one asset can offset losses in others. An optimal portfolio minimizes risk for a given return or maximizes return for a given risk. It is selected from the efficient frontier of portfolios with the highest return per level of risk. The security market line models the relationship between risk and expected return for individual assets based on the capital asset pricing model.
Diversification and portfolio analysis@ bec domsBabasab Patil
- Diversification reduces risk by combining assets whose returns are not perfectly positively correlated, thereby lowering portfolio risk without reducing expected returns. Markowitz diversification is more analytical than simple diversification by considering assets' correlations.
- Portfolio analysis involves calculating a portfolio's expected return and risk. The expected return is a weighted average of assets' individual expected returns, while risk is measured by portfolio standard deviation rather than a simple weighted average of individual risks. Correlations between assets are important for determining portfolio risk.
- The efficient frontier shows the set of optimal portfolios that offer the maximum expected return for a given level of risk. Individual investors will select different portfolios on the efficient frontier depending on their unique risk tolerances and utility
This document discusses portfolio analysis and security analysis. It defines portfolio analysis as determining the future risk and return of holding various combinations of individual securities. Portfolio analysis involves diversifying investments across different assets, industries, and companies to reduce non-systematic risk. The document contrasts traditional portfolio analysis, which focuses on lowest risk securities, with modern portfolio theory, which emphasizes combining high and low risk securities to maximize returns at a given level of risk. Key aspects of portfolio analysis include calculating expected returns, variance, and the standard deviation and beta of a portfolio to measure risk. Diversification is presented as an important tool to reduce unsystematic risk.
This document discusses risk and return as tools for investment in shares. It defines risk as variability between expected and actual returns and lists common types of risk including interest rate, market, financial, liquidity, and foreign exchange risk. Sensitivity analysis and the range are introduced as approaches to assess risk. Return is defined as income from investments plus changes in market price. Components of return include yield from interest and dividends as well as capital gains or losses. Total return takes into account yield and price changes. Risk and return can be analyzed using portfolios consisting of diversified financial assets. Common measures of risk are the mean and standard deviation calculated from sample return data.
This document discusses concepts related to risk and return analysis in finance. It defines key terms like return, expected return, risk measures including beta, standard deviation, and alpha. It also categorizes different types of risk and explores the relationship between risk and return. Methods for computing rates of return from market data and calculating variance and standard deviation of returns are presented.
This document discusses key concepts related to investment risk and returns. It defines investments, returns, and different types of returns including expected, required, actual, and market rates of return. It also discusses different types of risk like standalone and portfolio risk. Models for evaluating risk and return are covered, including the Capital Asset Pricing Model (CAPM) and Security Market Line (SML). The SML plots expected returns based on levels of systematic risk and can be used to identify overvalued and undervalued investments. Changes to the SML impact expected returns and the cost of capital for companies.
1. Portfolio management is a process of optimizing investment funds through activities like security analysis, portfolio construction, selection, revision and evaluation.
2. It involves choosing securities to create portfolios that balance risk and expected return. The optimal portfolio lies on the efficient frontier which shows maximum return for each risk level.
3. Risk is measured by variability of returns. The CAPM model relates expected return and systematic risk measured by beta for efficient portfolios on the SML and all securities.
Question 1Risk & Return and the CAPM. Based on the following.docxIRESH3
Question 1
Risk & Return and the CAPM.
Based on the following information, calculate the required return based on the CAPM:
Risk Free Rate = 3.5%
Market Return =10%
Beta = 1.08
Question 2
Risk and Return, Coefficient of Variation
Based on the following information, calculate the coefficient of variation and select the best investment based on the risk/reward relationship.
Std Dev.Exp. Return
Company A 7.4 13.2
Company B 11.6 18.9
Question 3
Risk and Return, Coefficient of Variation
Based on the following information, calculate the coefficient of variation and select the best investment based on the risk/reward relationship.
Std Dev.Exp. Return
Company A 10.4 15.2
· Company B 14.6 22.9
Question 4
Measures of Risk.
Address each source of risk that is measured and relate it to two models addressed in this unit.
· Your response should be at least 250 words in length.
BBA 3301, Financial Management 1
UNIT VI STUDY GUIDE
Risk and Return
Learning Objectives
Upon completion of this unit, students should be able to:
1. Explain the risk-reward relationship.
2. Calculate holding period returns.
3. Calculate required returns using the Capital Asset Pricing Model
(CAPM).
4. Calculate the coefficient of variation for varying investments.
5. Decompose sources of risk.
6. Contrast measures of risk.
7. Describe portfolio theory and diversification.
Written Lecture
Whenever a business or individual makes an investment decision, risk must be
considered. This unit focuses entirely on the risk-return relationship, providing
tools for measurement, analysis and decision making.
To begin, the term risk must be defined. From a practical or applied perspective,
risk is the probability of losing some or all of the money invested. In finance, risk
is often associated with volatility of variance in returns (around some average
return). Generally, it is assumed that investments that offer higher returns
involve greater risk. For purposes of this unit, risk is measured through two
primary measures:
Standard Deviation, and
The Beta Coefficient
The rate of return allows an investment's return to be compared with other
investments. For one-year investments, the return on a debt investment is:
k = interest paid / loan amount
The return on a stock investment is calculated by the following equation
k = [D1 + (P1 – P0)] / P0
Where:
D1 = Dividends for the “next” year (on a share of stock)
P1= Price of a share of stock, one period into the future
P0= Price of a share of stock today
The expected return on stock is the return investors feel is most likely to occur
based on current information. Return is influenced by the combination of stock
price (capita ...
This document discusses key concepts related to risk, return, and portfolio diversification. It defines return, risk, and expected return. It explains how to calculate expected return using probability distributions and the difference between arithmetic and geometric means. The document also discusses how standard deviation is used to measure risk and how portfolio risk is reduced through diversification as more securities are added. Finally, it summarizes the principles of random and Markowitz diversification in portfolio formation.
The document discusses various concepts related to security risk and return, including:
1. Calculating returns from security investments
2. Understanding historical return and risk
3. Efficient market hypothesis and its implications
4. Calculating expected returns and the impact of diversification on risk
It also covers risk-return tradeoff, systematic risk, security market line, and using the Capital Asset Pricing Model.
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This document discusses various theories of leadership:
i) Trait theories propose that leaders possess certain innate qualities and traits.
ii) Behavioral theories focus on specific leader behaviors that differentiate leaders from non-leaders. The Ohio State and University of Michigan studies identified key leader behaviors.
iii) Contingency theories emphasize that effective leadership depends on matching a leader's style to the context. Theories discussed include Fiedler Model, Situational Leadership Theory, and Path-Goal Theory.
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Here are the steps to solve this problem:
FV = PV(1 + r/n)nt
FV = $4,000(1 + 0.09)11
FV = $4,000(2.1435)
FV = $8,574
The future value of $4,000 invested for 11 years at 9% compounded annually is $8,574.
This document provides an overview of financial statement analysis and cash flow analysis. It defines key financial statements including the balance sheet, income statement, and statement of cash flows. It explains the purpose of financial statement analysis for both internal and external users. The document then describes various items and terms for each financial statement like assets, liabilities, equity, revenues, and expenses. It also introduces several important financial ratios to measure a company's liquidity, asset management, profitability, leverage, and market value. Formulas are provided for calculating common ratios.
The document provides an introduction to the foundations of financial management. It discusses key topics including the definition of finance, the roles and goals of financial managers, and basic principles and forms of business. Specifically, it outlines that the role of a financial manager is to make decisions regarding capital budgeting, capital structure, and working capital. Additionally, it states the goal of a firm is to maximize shareholder wealth through maximizing share price, rather than profit maximization.
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The document discusses a company's marketing strategy and planning process. It involves defining the company's mission and objectives, analyzing its current business portfolio, and identifying growth opportunities through tools like market penetration, development, product development, and diversification. The company designs an integrated marketing mix to create value for customers and achieve profitable relationships. It segments, targets, positions and differentiates itself in the marketplace. Marketing implementation, organization, budgets, and performance measurement allow the company to accomplish its strategic marketing goals.
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2. Learning Objectives
Define risk and return.
Identify risk and return relationship.
Calculate expected return and standard deviation.
Measure coefficient of variation.
Distinguish the different types of investment risks and
methods that is used to measure them.
Explain portfolios and risk diversification.
Calculate required rate of return based on CAPM.
3. Return represents the total gain or loss on an investment.
You invested in 1 share of Apple (AAPL) for $95 and sold
a year later for $200. The company did not pay any
dividend during that period. What will be the cash return
on this investment?
Cash Return = $200 + 0 - $95 = $105
Rate of Return = ($200 + 0 - $95) ÷ 95 = 110.53%
Return
4. Expected return is what you expect to earn from an
investment in the future.
It is estimated as the average of the possible returns, where
each possible return is weighted by the probability that it
occurs.
Where:
Pb1 = probability of occurrence of the outcome
r = return for the outcome
n = number of outcomes considered
Expected Return (k^ ) the return that an investor expects to earn on an
asset, given its price, growth potential, etc.
‡Required Return ( k- ) the return that an investor requires on an asset
given its risk and market interest rates.
•This expected rate of return is in the form of cash flow. In referring to
that, we will use cash flows in order to measure rate of return.
5. • Risk is defined as the chance of suffering a financial
loss. Or the potential variability in future cash flows.
• Risk may be used interchangeably with the term
uncertainty to refer to the variability of returns (possible
outcomes).
•The wider the range of possible future events that can
occur, the greater the risk.
• Potential variability in future cash flow The possibilityʹ
that an actual return will differ from our expected return.
• A greater chance of loss are considered more risky
than those with a lower chance of loss.
Risk
7. • Standard deviation (S.D.) is one way to measure risk. It
measures the volatility or riskiness of returns. (σ -sigma)
• S.D. = square root of the weighted average squared
deviation of each possible return from the expected return.
This variability in returns can be quantified by computing
the Variance or Standard Deviation in investment returns.
the standard deviation, σk, which measures the
dispersion around the expected value.
Measurement Risk
8. State of Probability Return
Economy (P)
Company A Company B
Recession 0.20 4% -10%
Normal 0.50 10% 14%
Boom 0.30 14% 30%
k (A) = .2 (4%) + .5 (10%) + .3 (14%) = 10%
k (B) = .2 (-10%)+ .5 (14%) + .3 (30%) = 14%
Based only on your expected return calculations,
which stock would you prefer?
Have you considered risk??????????
9. Company A
( 4% - 10%)2
(.2) = 7.2
(10% - 10%)2
(.5) = 0
(14% - 10%)2
(.3) = 4.8
Variance = 12
Stand. dev. = 12 = 3.46%
Company B
(-10% - 14%)2
(.2) = 115.2
(14% - 14%)2
(.5) = 0
(30% - 14%)2
(.3) = 76.8
Variance = 192
Stand. dev. = 192 = 13.86%
Company A company B
Expected Return 10% 14%
Standard Deviation 3.46% 13.86%
Which company is good. It depends on your tolerance for risk!
We can conclude that, company A has lower risk compared to investment
B BUT Company B has higher return.
Remember, there’s a tradeoff between risk and return.
Example
10. The coefficient of variation, CV, is a measure of relative
dispersion that is useful in comparing risks of assets with
differing expected returns.
CV = σ / k
The higher the CV, the higher the risk.
CV A = 3.46 % / 10%
= 0.346
CV B = 13.86% / 14%
= 0.99
A unit of risk in return for asset B is higher than asset A.
As a conclusion, asset A is less risky than asset B.
In comparing risk, it is more effective if we are using CV
because it’s consider the relative size or the rate of return.
12. Risk Measurement for a Single
Asset: Standard Deviation (cont.)
Table 1 The
Calculation of
the Standard
Deviation
of the Returns
for Assets A
and B
13. • An investment portfolio is any collection or combination of
financial assets.
• If we assume all investors are rational and therefore risk averse,
that investor will ALWAYS choose to invest in portfolios rather than in
single assets.
•Investors will hold portfolios because he or she will diversify away a
portion of the risk that is inherent in “putting all your eggs in one
basket.”
• If an investor holds a single asset, he or she will fully suffer the
consequences of poor performance.
• This is not the case for an investor who owns a diversified portfolio
of assets.
Portfolio and Diversification
14. ‡ Portfolio: Hold /Invest in different types of assets (or
investments) at the same time or period.
Combining several securities in a portfolio can actually
reduce overall risk.
‡ Example
Invest in different type of securities may lower the risk of
losses. This is because, if we loss in security B, probably, for
security A we will earn profit.
‡Reduction in risk through investing in securities that NOT
perfectly correlated. (assets with a negative correlation)
Portfolio and Diversification
15. Diversification: spreading out of investments to reduce risks.
‡ Investments across different securities rather than invest
in only one stock.
‡ Reducing a risk of portfolio is depends on the correlation
(r) between all of the stocks.
‡Correlation is a statistical measurement of the relationship
between two variables.
Positive Correlation
Negative Correlation
Possible correlations range from +1 to 1ʹ
Diversification
16. ‡ If two stocks are perfectly positively correlated, diversification has
NO effect on risk. i.e If correlation (r) = +1, we cannot abolish all the
risk. A correlation of +1 indicates a perfect positive correlation,
meaning that both stocks move in the same direction together.
‡ If two stocks are perfectly negatively correlated, the portfolio is
perfectly diversified. i.e If correlation (r) = -1, we can abolish the risk. A
correlation of -1 indicates a perfect negative correlation, meaning that
as one stock goes up, the other goes down.
Diversification
17. Investors should NOT expect to eliminate all risk from their
portfolio. Some risk can be diversified away and some cannot.
Market risk (systematic risk) is nondiversifiable. This type of risk
cannot be diversified away. Such as Unexpected changes in interest
rates. Unexpected changes in cash flows due to tax rate changes,
foreign competition, and the overall business cycle.
Company-unique risk (unsystematic risk) is diversifiable. This
type of risk can be reduced through diversification.
Such as A company’s labor force goes on strike.
A company’s top management dies in a plane crash.
A huge oil tank bursts and floods a company’s production area.
Investment risks
19. Market portfolio is a portfolio consisting of a weighted sum
of every asset in the market, with weights in the proportions
that they exist in the market.
ƒ Proxy can be used as a market portfolio such as S&P 500
Index in the U.S and Nikkei 225 Index in Japan.
ƒ In Malaysia, Bursa Malaysia (formerly known as KLSE) is one
of the proxies that can be used as market portfolio.
ƒ The movement in these indexes act as a benchmark to the
movement of the market.
Market portfolio
20. Systematic risk called non-diversifiable risk because it is beyond
the control of the investor and the firm.
ƒ Systematic risk reflects mainly macroeconomic shocks that
affect aggregate behavior of the economy.
ƒ Market risk measured by beta (β = 1)
Once the asset return and market return obtained, a graph is
prepare to see the relationship between asset return and market
return. ƒ Asset return and market return are plot on Y-X-axis.
ƒ When all the returns are plotted, draw a line of best-fit through
coordinate point (0,0), which we call Characteristic line.
Measuring market risk
21. Market returns and assets returns for certain period can be determined by
looking at the percentage of changes in index or price based on the
following equation:
kt = (Pt / Pt – 1) – 1
Asset Return & Market Return
Asset Market
Period Price Return Index Return
0 19.00 853.42
1 19.29 1.53% 869.10 1.84%
2 20.90 8.34% 900.67 3.63%
3 19.54 -6.51% 901.89 0.14%
4 21.50 10.03% 923.80 2.42%
Measuring return
22.
23. The slope of the line (beta), represents the average movement of
the firm’s stock returns in response to a movement in the market’s
return i.e the average relationship between a stock’s return and
market’s returns.
Interpreting beta ( )ɴ
A firm that has a beta = 1 has average market risk. The
stock is no more or less volatile than the market.
A firm with a beta >1 is more volatile than the market.
A firm with a beta < 1 is less volatile than the market.
A firm with a beta=0 has no systematic risk.
¾ Most stocks have betas between 0.60 and 1.60
Measuring market risk
24. Beta is a measure of how an individual stock’s returns
vary with market returns.
Beta measures of the sensitivity of an individual stock’s
return to changes in the market.
It indicates the average response of a stock’s return to the
change in the market as a whole.
ƒ Example
β = 1.2 means any increase/decrease by 1% in market return
will cause an increase or decrease by 1.2% in asset return.
Market risk
25. Portfolio beta indicates the percentage change on average of
the portfolio for every 1 percent change in the general
market.
The portfolio beta is a weighted average of the individual
asset's beta and assets has its own beta.
β portfolio= Σ wj*βj
Where wj = % invested in stock j
βj = Beta of stock j
Measuring portfolio beta
26. We know how to measure risk, using standard deviation for
overall risk and beta for market risk.
We know how to reduce overall risk to only market risk through
diversification.
We need to know how much extra return we should require for
accepting extra risk.
What is the Required Rate of Return?
The return on an investment required by an investor given market
interest rates and the investment’s risk.
ƒ The minimum rate of return necessary to attract an investor to
purchase or hold a security.
ƒ The required return for all assets is composed of two parts: the
risk-free rate which is usually estimated from the return on treasury
bills and a risk premium which is a function of both market
conditions and the asset itself.
Required Rate of Return (CAPM)
27. This linear relationship between risk and required return is
known as the Capital Asset Pricing Model (CAPM).
CAPM equation equates the required rate of return on a
stock to the risk-free rate plus a risk premium for the systematic
risk.
The equation indicates that investor’s minimum acceptable rate of
return is equal to the risk-free rate plus a risk premium for assuming
risk.
Required Rate of Return (CAPM)
28. The Security Market Line (SML) is a graphic representation
of the CAPM, where the line shows the appropriate required
rate of return for a given stock’s systematic risk.
CAPM- SML
29. Risk-Free Rate: This is the required rate of return or discount
rate for risk-less investments. Risk-free rate is typically measured
by U.S. Treasury bill rate.
Risk Premium: Additional return we must expect to receive for
assuming risk. As the level of risk increases, we will demand
additional expected returns.
The risk premium for a stock is composed of two parts: The
Market Risk Premium which is the return required for investing in
any risky asset rather than the risk-free rate.
Beta, a risk coefficient which measures the sensitivity of the
particular stock’s return to change in market conditions.
CAPM- SML
30. CAPM
Example: ABC Corporation wishes to determine the required return on asset
Z, which has a beta of 1.5. The risk-free rate of return is 7%; the return on
the market portfolio of assets is 11%.
K Z = 7% + 1.5 [11% - 7%]
= 13% According to the CAPM, Asset Z should be priced to give a 13% return.
31. REQUIRED RATE OF RETURN - CAPM
Investor’s required rate of returns is the minimum rate of
return necessary to attract an investor to purchase or hold a
security.
The required return for all assets is composed of two parts:
the risk-free rate and a risk premium.
The risk-free rate (Rf) is usually
estimated from the return on
treasury bills
The risk premium is a function of
both market conditions and the
asset itself.
32. Required
rate of
return
32
.
(7%)
Risk-
free
rate of
return
Beta
13%
1.5
(SML)
This linear relationship
between risk and required
return is known as the
Capital Asset Pricing Model
(CAPM).
SML – The line that reflect the attitude of investors
regarding the minimal acceptable return for a given level
of systematic risk.
11%
1.0
Risk Premium
Market Risk Premium
Risk Free Rate