Beruflich Dokumente
Kultur Dokumente
Fernandes, CFPCM
By Steven Fernandes
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Risk & Return
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Return:-
Means Reward
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Two Components
Capital Return
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Capital Return:-
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Risk
Meaning:-
Refers to the possibility that the actual outcome
Of an Investment will differ from its expected
Outcome..
Risk means Variability or Dispersion
If an assets return has no variability, it is
Riskless. (Govt bonds, Secured FDs)
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Examples of Risk associated with
Investments
o Loss of Capital
For eg. Shares, Equity MFs
o Variability of Returns
Eg. Shares, Income funds 8
Three types of Risk
Business Risk
Market Risk
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Business Risk:-
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Interest Rate Risk:-
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Market Risk:-
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John Train:
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TYPES OF RISK
UNIQUE RISK
Specific to that security. For eg. Labour strike, new competitor
Diversifiable or unsystematic risk
MARKET RISK
Economy wide factors like low GDP, high inflation, money
supply, interest rate fluctuations, etc
Systematic risk or Non Diversifiable risk.
Total Return
Relative Return
Arithmetic Mean
Geometric Mean
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Measures of Historical Returns
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Total Return:-
Cash Payment recd. Price change over
during the period + the period
Price of the Investment at the beginning
R = C + (Pe-Pb)
Pb
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Example
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Solution
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Relative Return:-
(In order to avoid negative returns calculations)
Relative Return =
Rr = C+ Pe
Pb 21
Note:-
Even though the Total Return may be negative,
The Relative Return cannot be negative.. At
worst it can be zero.
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Cumulative Wealth Index (CWI) :-
Total Return = Changes in level of Wealth
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Formula
Where:-
CWI n = Cum. Wealth Index at the end of n years.
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Arithmetic Mean
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Formula:-
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Example
Calculate AM for the following Returns
Year Total Return (%)
1 19
2 14
3 22
4 -12
5 5
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Problem with Arithmetic Mean:-
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Return for Yr. 1 = 80 100 = - 0.20 or 20 %
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Its Misleading!
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Formula
GM = (Relative Returns)1/n - 1
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Example:-
Year Total Return (%) Relative Ret.
1 19 1.19
2 14 1.14
3 22 1.22
4 -12 0.88
5 5 1.05
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Geometric Mean :-
= 1.089 1 = 0.089
= 8.9 %
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Note:-
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Measures of Risk
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Measures of Risk
Standard Deviation ( )
= Square Root of Variance.
= 2
Financial calculator :
Variance ( 2)
2= ( Ri- ) 2
n-1
Where
2 = variance of return
Ri = Return of stock in period I (i = 1,2 n)
= Arithmetic mean 39
n- = number of periods
Measures of Risk
Numerical Eg.
1. Consider the returns from a stock over a 6 year period.
Period 1 2 3 4 5 6
Return
(Ri) 15 12 20 -10 14 9
Rate of
Return (%)
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Measures of Risk
(Measuring Expected (Ex Ante) return & risk)
Variance ( 2)
2= Pi ( Ri - E(R) )
Standard Deviation ( )
= 2
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Measures of Risk
(Measuring Expected (Ex Ante) return & risk)
Numerical : Rate of
Return
(%)
Probability
of
Occurrence HLL PiRi Ri- E ( R) (Ri- E ( R) )2 Pi(Ri - E (R ) )
0.3 16 4.8 4.5 20.25 6.075
0.5 11 5.5 -0.5 0.25 0.125
0.2 6 1.2 -5.5 30.25 6.05
11.5 12.25
1. E( R) = (0.3x16)+(.5x11)+(.2x6) = 11.5
2. 2 = Pi ( Ri E(R) )
= (6.075+.125+6.050) = 12.25
3. = 2 = 12.25 = 3.5
Financial Calculator
Go to Setup , Stats on, stats , select (1-vari), Exe, Key in data (returns in x & prob in
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freq) take cursor to next empty field, press (shift & stats), 5 : Var, 3
Risk
Variance S.D2 (2) of 2 Asset portfolio =
w1212 + w2222 + 2w1w2Covariance(A,B)
where Covariance(A,B) = 12Correlation(A,B)
= 121,2
Covariance is the degree to which the returns of 2 securities vary or
change together
Correlation and Covariance both reflect the degree of co-movement
between 2 variables. Mathematically related
Coefficient of Correlation can vary between 1 and +1
As you add more securities to a portfolio, impact of risk of each
portfolio reduces, at the same time the significance of their
covariance increases.
The key to reducing portfolio risk is to combine assets that are less
than perfectly positively correlated
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Risk
S.D2 (2) of 3 Asset portfolio =
w1212 + w2222 + w3232 + 2w1w2121,2 +
2w2w3232,3+ 2w1w3131,3
Covariance(A,B) = 12 = 121,2
1,2 = 12 / 12
When the Correlation Coefficient is 1,
representing perfect negative correlation, the
portfolio risk can be driven down to 0.
The weights that drive the standard deviation of
portfolio to 0 are:
w1 = 2 / (1+ 2) , w2 = 1 / (1+ 2)
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Risk
of Security is a Measure of its performance in relation
to general movement in markets. I.e. % change in
security returns w.r.t % change in market returns
E.g. if Security returns increase by 18% when market
increases by 10% then = 18/10 = 1.8
High means security is very sensitive to market
changes
cannot be negative
= 0 => security does not change even when market
changes I.e. Security is Risk free
= 1 => security moves in line with market
> 1 => security returns are more than changes in
market returns (aggressive securities)
< 1 => security returns are less than changes in
market returns (defensive securities)
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Risk decomposition
CAPM : Linear relationship between required
rate of return of a security and its beta
Ri = Rf + i (Rm-Rf)
Risk free rate + Risk premium
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Three measures of Performance
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Example:-
Particulars A Market
Return(%) 14 12
Beta 1.1 1
SR = Rp Rf = 14 5 = 0.9
SD 10
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Treynor Ratio
Jack L Treynor
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Particulars A Market
Return(%) 14 12
Beta 1.1 1
Std. Deviation 0.10
Risk Free Rate(%) 5
Calculate Treynor Ratio
TI = Rp - Rf = 14 5 = 8.181
B 1.1
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Beta
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Jensens Alpha
Ex Post Alpha
( Michael Jensen )
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Jensens Alpha
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Particulars A Market
Return(%) 14 12
Beta 1.1 1
Std. Deviation 0.10
Risk Free Rate(%) 5
Calculate Jensens Alpha
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