This document discusses the concepts of risk and return in investments. It defines risk as the uncertainty of expected returns, which can be caused by factors both related and unrelated to the investment. Systematic risk refers to uncertainty from broader market factors that affect all investments, while unsystematic risk is specific to a particular investment. Standard deviation and beta are introduced as quantitative measures of risk. Standard deviation measures how much returns vary from the average, while beta measures the volatility of a security compared to the overall market. The security market line equation is presented to demonstrate how beta is used to determine the required rate of return based on the risk-free rate and market risk premium.
Many investors mistakenly base the success of their portfolios on returns alone. Few consider the risk that they took to achieve those returns. Since the 1960s, investors have known how to quantify and measure risk with the variability of returns, but no single measure actually looked at both risk and return together. Today, we have three sets of performance measurement tools to assist us with our portfolio evaluations. The Treynor, Sharpe and Jensen ratios combine risk and return performance into a single value, but each is slightly different. Which one is best for you? Why should you care? Let's find out.
Portfolio performance measures should be a key aspect of the investment decision process. These tools provide the necessary information for investors to assess how effectively their money has been invested (or may be invested). Remember, portfolio returns are only part of the story. Without evaluating risk-adjusted returns, an investor cannot possibly see the whole investment picture, which may inadvertently lead to clouded investment decisions.
Many investors mistakenly base the success of their portfolios on returns alone. Few consider the risk that they took to achieve those returns. Since the 1960s, investors have known how to quantify and measure risk with the variability of returns, but no single measure actually looked at both risk and return together. Today, we have three sets of performance measurement tools to assist us with our portfolio evaluations. The Treynor, Sharpe and Jensen ratios combine risk and return performance into a single value, but each is slightly different. Which one is best for you? Why should you care? Let's find out.
Portfolio performance measures should be a key aspect of the investment decision process. These tools provide the necessary information for investors to assess how effectively their money has been invested (or may be invested). Remember, portfolio returns are only part of the story. Without evaluating risk-adjusted returns, an investor cannot possibly see the whole investment picture, which may inadvertently lead to clouded investment decisions.
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 ...
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2024.06.01 Introducing a competency framework for languag learning materials ...Sandy Millin
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Published classroom materials form the basis of syllabuses, drive teacher professional development, and have a potentially huge influence on learners, teachers and education systems. All teachers also create their own materials, whether a few sentences on a blackboard, a highly-structured fully-realised online course, or anything in between. Despite this, the knowledge and skills needed to create effective language learning materials are rarely part of teacher training, and are mostly learnt by trial and error.
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3. According to dictionary meaning : The
existence of volatility in the occurrence of an
expected incident is called risk .Higher the
unpredictability greater is the risk.
4. Wrong method of investment
Wrong timing of investment
Wrong quality of investment
interest rate risk
Maturity period or length of investment
Terms of lending
National and international factors
Natural calamities
6. Systematic risk refers to that portion of variation
in return caused by factors that affect the prices
of all securities .This risk cannot be avoided or
ignore .The effect of return causes the prices of
all individual securities to move in the same
directions .systematic risk arises due to the
following factors:
7. a. Market risk : Variations in prices sparked off
due to real social, political and economic events
is referred to as market risk .Market risk arises
out of changes in demand and supply pressures
in the market following the changing flow of
news or expectations .
b. Interest rate risk :Generally price of securities
tend to move inversely with changes in the rate
of interest. The market activity and investor
perceptions are influenced by changes in the
interest rate which turn depend on the nature
of stocks,bonds,loans etc maturity of the
periods and the credits worthiness of the issuer
of the securities.
8. Purchasing power risk : uncertainty of
purchasing power is referred to as risk due to
inflation. Inflation arouses optimism since all the
prices group and that lead to higher incomes. But
the effect of this hike in incomes increases and
cost of production due to wage rise, rise in prices
of raw material etc. There is a possibility of prices
of desired goods and services going up due to
inflation .
9. Unsystematic risk refers to that portion of the
risk which is caused due to factors unique or
related to a firm or a industry. This risk is
company specific risk and can be controlled if
proper measures are taken. It is caused by
the factors like labors, shortage of power,
recession in particular industry etc.
10. Business risk : Business risk can be internal as all as
external. Internal risk is caused due to improper
product mix ,non availability of raw materials, absence
of strategic management etc. External risk arises due to
change in operating conditions caused by conditions
thrust upon the firm which are beyond its control
eg;business cycle, government controls, international
market conditions etc.
Financial risk : This risk is associated with the capital
structure of a company. A company with no debt
financing has no financial risk. The extent of financial
risk depends on the leverage of the firms capital
structure.
Credit or default risk :The credit risk deals with the
probability of meeting with a default. It is primarily the
probability that a buyer will default. Proper
management can reduce the chances of non payment
of loan .
13. It is a measure of the value of the variables around
its mean or it is the square root of the sum of the
squared deviation from the mean divided by the
number of observances . The arithmetic mean of
the return may be same for two companies but
the return may vary widely.
Or
Standard Deviation as a Measure of Risk. The
standard deviation is often used by investors to
measure the risk of a stock or a stock portfolio.
The basic idea is that the standard deviation is a
measure of volatility: the more a stock's returns
vary from the stock's average return, the more
volatile the stock.
14.
15.
16.
17. Y P(Y) Y* P(Y) Y 2 * P (Y)
7 0.25 1.75 12.25
15 0.50 7.50 112.50
23 0.25 5.75 132.25
Total 1.00 15.00 257
S.D = S Y2 * P(Y) – [S Y*P(Y)]2
S.D = 257 – (15) 2 = 5.66 rupees
18. STOCK A STOCK B
Expected Return 15 rupees 15 rupees
Standard
Deviation
1.41 rupees 5.66 rupees
Comparing the two stocks, we see that both stocks have
the same expected returns. But the SD or risk is different.
The S.D of stock B > S.D of stock A
We can say that the return of stock B is prone to higher
19. CV is a measure of relative risk.
It tells us the risk associated with each unit of money
invested.
Formula:
CV = s(x) / E(X)
23. Beta describes the relationship between the stock return
and index return. Beta describes the systematic risk
Beta =+1.0 one percent change in the market index
return causes exactly one percent change in stock return.
It indicates that the stock moves in tandem with the
market .
Beta =+0.5 one percent change in the market index return
causes exactly 0.5percent change in stock return. It
indicates that the stock is less volatile compared to the
market.
Beta =+2.0 one percent change in the market index
return causes exactly 2 percent change in stock return. It
indicates that the stock is more volatile. When there is a
decline of 10%in the market return the stock with beta 2
would give a negative return of 20%.
24. Suppose the risk free rate of the security is 6%
The market rate is 12% and the beta is 1.25,
Then the required rate of return for the security would be
R = 6 + (12 – 6) * 1.25
R = 6 + 7.5
R = 13.5%
Reconsider the above example but suppose that the value of B = 1.60. Then the
return would be:
R= 6 + (12 – 6)*1.60
R= 6 + 9.6
R= 15.6%
So, we see that greater the value of beta, the greater the systematic risk and in
turn the greater the required rate of return.