Beruflich Dokumente
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OBJECTIVES
OBJECTIVES
Understand the meaning and fundamentals of risk
and return
Describe procedures for assessing and measuring
risk of a single asset
Understand the risk and return for a portfolio
Risk and return for Capital Asset Pricing Model
(CAPM)
investment over a
Return =
Return = 5%
Asset B
$ 10,000
$ 10,000
Pessimistic (worst)
13%
7%
15%
15%
Optimistic (best)
17%
23%
RANGE
4% (from 17%-13%)
Asset B
$ 10,000
$ 10,000
Pessimistic (worst)
13%
7%
15%
15%
Optimistic (best)
17%
23%
4% (from 17%-13%)
**The greater the range, the more variability, or risk, the asset is to
have.**
Therefore, a risk-averse decision maker would prefer asset A
because it offers the same expected (most likely) return with lower
risk smaller range.
Asset A
Asset B
Returns
Value
Returns
Value
Pessimistic (worst)
0.25
13%
3.25
7%
1.75
0.50
15%
7.50
15%
7.50
Optimistic (best)
0.25
17%
4.25
23%
5.75
TOTAL
15.00%
Asset A
Asset B
0.5
0.5
0.25
0.25
15.00%
0.25
Asset A
Note: Although the two assets have the same average return (15 percent),
the distribution of returns for asset B is much greater dispersion than
the distribution of asset A. Thus, asset B is more risky than asset A
Firm Y
-70
15
100
Rate of
Return (%)
Asset A
Asset B
Returns
Value
Returns
Value
Pessimistic (worst)
0.25
13%
3.25
7%
1.75
0.50
15%
7.50
15%
7.50
Optimistic (best)
0.25
17%
4.25
23%
5.75
TOTAL
15.00%
Where:
15.00%
Where:
Asset B
)()
-)2)
)()
-)2)
Pessimistic
0.25
13%
3.25
1%
7%
1.75
16%
Most Likely
0.50
15%
7.50
15%
7.50
Optimistic
0.25
17%
4.25
1%
23%
5.75
16%
TOTAL
=15 %
=
= 1.41%
=15 % =
= 5.66%
NOTE:
A higher standard deviation indicates a greater project risk.
With a larger standard deviation, the distribution is more
dispersed and the outcomes have a higher variability,
resulting in higher risk.
CV
Coefficient Variation = Standard Deviation
Expected return
A higher coeficient of variation means that an investment has more
volatility relative to its expected return.
For risk averse investors, they may gravitate towards investments
with lower coefficient of variation.
Risk of a Portfolio
PORTFOLIO RETURN AND STANDARD
DEVIATION
Risk of a Portfolio
Portfolio Defined
- It is a group of financial assets such as stocks, bonds and cash
equivalents, as well as their mutual, exchange-traded and
closed-fund counterparts.
- The goal of financial manager is to create an efficient
portfolio.
Efficient Portfolio A portfolio that maximizes return for a
given level of risk
Risk of a Portfolio
PORTFOLIO
RETURN
Return on a portfolio (rp) is the weighted average of the
returns on the individual asset from which it is formed.
rp = (w1 X r1) + (w2 X r2) + (wn X rn)
Where:
Risk of a Portfolio
EXAMPLE:
James purchases 100 shares of Wal-Mart at a price of 55 per
share, so his total investment in Wal-Mart is $ 5,500. He also
buys 100 shares of Cisco Systems at $25 per share, so the
total investment in Cisco is $ 2,500. Combining these two
holdings, James total portfolio is worth $ 8,000. Of the total,
68.75% is invested in Wal-Mart ($5,500/$8,000) and
31.25% is invested in Cisco Systems ($2,500/$8,000).
Stock Value
Purchased
# Shares
$ Value
Wal-Mart
$ 55
100
$ 5,500
68.75%
w1= 0.6875
Cisco
$ 25
100
$ 2,500
31.25%
w2= 0.3125
TOTAL
$ 8,000
w1+w2= 1
Risk of a Portfolio
STANDARD DEVIATION OF A PORTFOLIO
RETURN:
This found by applying the formula for the standard
deviation of a single asset.
This formula is used when probabilities of
the returns are known.
Risk of a Portfolio
EXAMPLE:
Determining the expected value and standard deviation for
portfolio XY, created by combining equal portions (50%
each) of assets X and Y. Five years returns of assets forecast
on table below.
Year
Forecasted Return
Asset X
Asset Y
Portfolio Return
Calculation
Exp.
Retrn.
2013
8%
16%
12%
2014
10%
14%
12%
2015
12%
12%
12%
2016
14%
10%
12%
2017
16%
8%
12%
Risk of a Portfolio
EXPECTED VALUE OF RETURN:
The expected value of
return in a Single Asset
Risk of a Portfolio
EXAMPLE:
Forecasted Return
Asset X
Asset Y
Portfolio Return
Calculation
Exp.
Retrn.
2013
8%
16%
12%
2014
10%
14%
12%
2015
2016
12%
14%
12%
10%
12%
12%
2017
16%
8%
(0.50 X 16%) + (0.50 X 8%)
EXPECTED VALUE OF PORTFOLIO RETURNS
12%
= (12%+12%+12%+12%+12%) 5
= 60% 5
= 12%
Risk of a Portfolio
EXAMPLE:
The standard deviation is calculated to be 0%. This is because
the portfolio return each year is the same (12%).
Portfolio returns do not vary through time.
0%
Risk of a Portfolio
CORRELATION
Correlation is the statistical measure of the relationship between any two
series of numbers
Positively correlated Describes two series that move in the same direction.
Negatively correlated - Describes two series that move in opposite direction.
Risk of a Portfolio
CORRELATION
Correlation Coefficient The measure of the degree of
correlation between two series.
Perfectly Positively Correlated Describes two positively
correlated series that have a correlation coefficient of +1.
Negatively correlated - Describes two positively correlated
series that have a correlation coefficient of -1.
Uncorrelated Describes two series that lack any interaction
and therefore have a correlation coefficient close to zero.
Risk of a Portfolio
DIVERSIFICATION
Combining negatively, correlated assets to reduce, or diversify risk.
Diversification Reduces Risk
By spreading your portfolio out among several investments, you
reduce the total amount committed to any one investment. If you
evenly split your portfolio between 5 investments and one goes
down the drain, youve still got your other 4 investments to fall back
on. If youd put everything in that one bad investment, you would
have nothing left.
In this sense, diversification is putting your eggs in different
baskets. By not betting everything on one investment, you lessen
the risk of losing everything all at once
Risk of a Portfolio
DIVERSIFICATION
Risk of a Portfolio
DIVERSIFICATION
International Diversification
The inclusion of assets from countries with business cycles that
are not highly correlated with the U.S. Business cycle, reduces
the portfolios responsiveness to market movements.
Risk of International Diversification
- Currency fluctuations
- Political Risk
B. Non-diversifiable Risk
where;
wj = proportion of the portfolios dollar value.
INVESTMENT
Risk premium
(rm-RF) or also (km-RF)
Stocks
Treasury Bond
where;
r* = assumed real rate of interest
IP = Inflation Premium