Risk & Return
INTRODUCTION
Most important business decisions entail two key
financial considerations: risk and return.
Each financial decision presents certain risk and return
characteristics, and the combination of these
characteristics can increase or decrease a firm’s share
price. Analysts use different methods to quantify risk,
depending on whether they are looking at a single asset
or a portfolio—a collection or group of assets. We will
look at both, beginning with the risk of a single asset.
WHAT IS RISK?
A measure of the uncertainty surrounding the return
that an investment will earn.
WHAT IS RETURN?
WHAT IS EXPECTED
The total gain or loss experienced on an investment
over a given period expressed as a percentage of the
investment’s value; calculated by dividing the asset’s
cash distributions during the period, plus change RETURN?
in value, by its beginning-of period value.
The return that an asset is expected to generate in the
future, composed of a risk-free
rate plus a risk premium
RISK PREFERENCES
Risk seeking: The attitude Risk neutral: The attitude Risk averse: The attitude
toward risk in which investors toward risk in which investors toward risk in which investors
prefer investments with choose the investment with require an increased expected
greater risk, perhaps if they the higher expected return return as compensation for an
have lower expected return regardless of its risk increase in risk
RISK OF A SINGLE ASSET
Risk assessment with scenario analysis which uses several possible alternative outcomes
to obtain the sense of the variability of returns.
RISK OF A SINGLE ASSET
Risk measurement : Standard Deviation
RISK OF A SINGLE ASSET
Risk measurement : The Coefficient of Variation (CV)
A measure of relative dispersion that is useful in comparing the risks of assets with
differing expected returns.
RISK OF A
PORTFOLIO
In real world situation, the risk of any single investment
would not be viewed independently of other assets. New
investments must be considered in light of their impact
on the risk & return of an investor's portfolio of assets.
The financial manager's goal is to create an efficient
portfolio, one that provides the maximum return for a
given level of risk.
RISK OF A
PORTFOLIO
Correlation is a statistical measure of the relationship
between any two series of numbers : positively
correlated or negatively correlated
The concept of correlation is essential to developing an
efficient portfolio. To reduce overall risk, its best to
diversify by combining or adding assets that have the
lowest possible correlation to the portfolio.
The Capital Asset
Pricing Model (CAPM)
Types of risks:
The Capital Asset
Pricing Model (CAPM)
Beta coefficient: relative measure of non-diversifiable risk
The Capital Asset
Pricing Model (CAPM)
The Equation
The Capital Asset
Pricing Model (CAPM)
The Security Market Line (SML)
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