RISK & RETURN

(SINGLE ASSET & PORTFOLIO)

Risk and Return
Risk is a measure of the uncertainty surrounding the return that an investment will
earn or, more formally, the variablity of returns associated with a given asset (Gitman,
2010:310).
Types of risk:
1. Diversifiable risk
(unsystematic risk) represents
the portion of an assets risk that
is associated with random
causes that can be eliminated
through diversification.
2. Nondiversifiable risk
(systematic risk) is attributable
to market factors that affect all
firms; it cannot be eliminated
through diversification.
(Gitman, 2006: 247)
RETURN
The return is the total gain or loss experienced on an investment over a given period of time.
(Gitman, 2006: 226)
Return is the ratio of money gained or lost (whether realized or unrealized) on an investment
relative to the amount of money invested. The amount of money gained or lost may be
referred to as interest, profit/loss, gain/loss, or net income/loss. The money invested may be
referred to as the asset, capital, principal, or the cost basis of the investment. When a share is
purchased, the return investors will expect from the share will come in two forms:
- a dividend (a special form of cash interest payment to shareholders as a return for their
investment in the firm),
- a capital gain or loss (which will depend upon whether the price of the share has
increased or decreased relative to the purchase price).

Basic return equation:

= actual, expected, or required rate of return during period t

= cash (flow) received from the asset investment in the time period t 1 to t

= price (value) of asset at time t

= price (value) of asset at time t 1

CAPITAL ASSET PRICING MODEL (CAPM)
The capital asset pricing model (CAPM) links nondiversifiable risk and return for all assets.
(Gitman, 2006: 247)
Capital Asset Pricing Method (CAPM) uses beta to relate an assets risk relative to the
market to the assets required return. CAPM consist of two parts, Risk free rate and asset risk
premium. The asset risk premium, consist of market risk premium and beta (). Market risk
premium is the return required for investing in any risky asset rather than the risk-free rate.
Beta is a risk coefficient, which measure the sensitivity of the particular assets return to
changes in market conditions.
CAPM Equation:

= required return on asset j

= risk-free rate of return

= beta coefficient or index of nondiversifiable risk for asset j

= market return; return on the market portfolio of assets

= risk premium

) = market risk premium

Beta coefficient is a relative measure of nondiversifiable risk. An index of degree of
movement of an assets return in response to a change in the market return (Gitman,
2009:250)
CAPM Assumptions: Efficient Market
1. Many small investors, all having the same information and expectations with respect to
securities,
2. No restrictions on investment, no taxes, no transaction costs,
3. Rational investors, who view securities similarly and are risk-averse, preferring higher
returns and lower risk.
The Security Market Line (SML)
The depiction of the capital
asset pricing model (CAPM)
as a graph that reflects the
required return in the
marketplace for each level of
nondiversifiable risk (beta).
(Gitman, 2006: 252)
Shift in the security market
line affected by:
Changes in inflationary
expectations (

)
Changes in risk
aversion (level of return)

)]
Estimated Beta
Beta can be Persamaan regresi estimated with :
a. Manual,
by plotting a straight line between the dots in a scatter diagram depicting the relationship
between the returns of securities with a market return. Beta is the slope of the straight
line.
b. Regression
Beta can be estimated based on Single Index Model (SIM) dan Capital Asset Pricing
Model (CAPM).



c. Equation Beta

Keterangan :

= covarians return between stock i with market return

= varians market return

= return stock i in time t

= average stock i in time t

= market return in time t

= average market return in time t

Persamaan CAPM :


Equation SIM :



RISK & RETURN MEASUREMENT


Portfolio Single Asset

Expected
Return

=
=
n
t
i
i
p R X R
1

n
R
R
n
t
jt
j

=
=
1

Std. Deviation

= = =
+ =
n
i
n
j
ij j i j i
n
t
i i p
X X X
1 1 1
2 2
o o o o

1
) (
1
2

=

=
n
R R
n
j
j j
j
o
Variance
( )
2
2
p
p p
R R E = o

1
) (
1
2
2

=
n
Rj R
n
j
j
j o
CV
p R
CV
p
o
=
j R
CV
k
o
=



RISK & RETURN
Single Asset Portfolio
Probabilistik Non-Probabilistik
1. Mean Return
2. Standard Deviation
3. Variance
4. Coefficient of Variation (CV)
1. Mean Return
2. Standard Deviation
3. Variance
4. Coefficient of Variation (CV)
5. Beta
CHAPTER II
RISK AND RETURN SINGLE ASSET
1. Portfolio
Stitch Corporation has portfolio investment planning in these two assets. As the financial
analyst, you are asked to give recommendation of the best portfolio combination for
Stitch Corporation. The prices of the assets are shown:
Date
Stock Price
ENGR KIJA JKSE
16/02/2012 192 189 3927,61
21/02/2012 188 192 4002,95
23/02/2012 191 195 3958,81
27/02/2012 192 191 3861,02
29/02/2012 195 190 3985,21
05/03/2012 194 191 3984,9
06/03/2012 197 190 3967,08
a. Calculate the return of each asset.
b. Calculate the expected return of each asset.
c. Find the risk of each asset by calculating the variance and standard deviation.
d. Find beta each asset using Capital Asset Pricing Model. Risk free 2012 is 5.75%
e. Find the expected return, variance, and standard deviation of the portfolio with
weighted variation :
F. Based on your calculation, which portfolio that you will choose as recommendation?
Why?

Portofolio 1: 70 ENRG : 30 KIJA PORT 2: 50 ENRG: 50 KIJA
The coefficient of correlation for the two assets (KIJA ENRG) is -0,378077434