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Risk and Return Manajemen Keuangan

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INTRODUCTION

UNIVERSITAS TERBUKA

Outline

2

Introduction

What is risk?

An overview of market performance

Measuring performance

Return and risk measures

Introduction

3

and return so we can determine appropriate risk-

adjusted discount rates for our NPV analysis.

At least as important, the relation between risk and

return is useful for investors (who buy securities),

corporations (that sell securities to finance

themselves), and for financial intermediaries (that

invest, borrow, lend, and price securities on behalf of

their clients).

What is risk?

4

between the actual outcome and what is expected.

In finance, risk is usually related to whether expected

cash flows will materialize, whether security prices

will fluctuate unexpectedly, or whether returns will

be as expected.

An overview of market performance – is there

risk?

5

January 1930 to October 2002

12000

10000

8000

6000

4000

2000

0

Jan-30

Jan-35

Jan-40

Jan-45

Jan-50

Jan-55

Jan-60

Jan-65

Jan-70

Jan-75

Jan-80

Jan-85

Jan-90

Jan-95

Jan-00

An overview of market performance – is there

risk?

6

January 1930 to October 2002

40%

30%

20%

10%

0%

-10%

-20%

-30%

-40%

Jan-30

Jan-35

Jan-40

Jan-45

Jan-50

Jan-55

Jan-60

Jan-65

Jan-70

Jan-75

Jan-80

Jan-85

Jan-90

Jan-95

Jan-00

An overview of market performance – is there

risk?

7

November 1984-October 2002

5200

4700

4200

3700

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2700

2200

1700

1200

700

200

Nov-84

Nov-86

Nov-88

Nov-90

Nov-92

Nov-94

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Nov-98

Nov-00

An overview of market performance – is there

risk?

8

Monthly % Change in

NASDAQ Composite Index

October 1984 to October 2002

30%

20%

10%

0%

-10%

-20%

-30%

Nov-84

Nov-86

Nov-88

Nov-90

Nov-92

Nov-94

Nov-96

Nov-98

Nov-00

An overview of market performance – is there

risk?

9

April 1984 - October 2002

12000

11000

10000

9000

8000

7000

6000

5000

4000

3000

2000

Apr-84

Apr-85

Apr-86

Apr-87

Apr-88

Apr-89

Apr-90

Apr-91

Apr-92

Apr-93

Apr-94

Apr-95

Apr-96

Apr-97

Apr-98

Apr-99

Apr-00

Apr-01

Apr-02

An overview of market performance – is there

risk?

10

Monthly % Changes of

S&P/TSX Composite Index

April 1984-October 2002

20.0%

10.0%

0.0%

-10.0%

-20.0%

-30.0%

May-84

May-85

May-86

May-87

May-88

May-89

May-90

May-91

May-92

May-93

May-94

May-95

May-96

May-97

May-98

May-99

May-00

May-01

May-02

Measuring Performance: Returns

11

= Dividends + End of Period Price – Beginning of Period Price

=Dollar return/Beginning of Period Price

=(Dividends + End of Period Price)/Beginning of Period Price -1

1. P0=$50, Div1=$2, P1=$55.50

2. P0=$20, Div1=$0.25, P1=$12.75

3. P0 = $30, Div1=$1, Capital Gain=$5

4. P0 = $130, Div1=$0, Capital Loss=$128

Holding Period Returns

Let Rt be the observed return

T

1 HPR 1 to T 1 R t

earned in year t, then the

holding period return over a T-

period time frame is as follows: t 1

return or geometric average rate

of return (GAR) just converts

the HPR to an equivalent

effective annual rate:

1

T

1 GAR 1 to T 1 HPR 1 to T

1

(1 R t )

T

T

t 1

12

Mean returns

The mean return is the T

arithmetic average rate of

return and is calculated as

R t

Mean return R t 1

follows: T

13

The risk premium

14

security minus the return on a risk-free security (often

T-bills are used as the risk-free security)

Another name for a security’s risk premium is the excess

return of the risky security.

The market risk premium is the return on the market

(as a whole) minus the risk-free rate of return.

We may talk about the past observed risk premium,

the average risk premium, or the expected risk

premium.

Risk Measures

15

distributed. Two statistics describe a normal distribution, the mean

and the standard deviation (which is the square root of the

variance). The standard deviation shows how spread out is the

distribution.

For stock returns, a more spread out distribution means there is a

higher probability of returns being farther away from the mean (or

expected return).

For our estimate of the expected return, we can use the mean of

returns from a sample of stock returns.

For our estimate of the risk, we can use the standard deviation or

variance calculated from a sample of stock returns.

Sample standard deviation and variance

Sample variance is a

measure of the squared

deviations from the

mean and is calculated

as follows:

s 2 Var

1 T

Rt - R

2

T 1 t 1

sample variance:

16

How to interpret the standard deviation as a measure

of risk

17

there is about a 68.26% probability that the actual return will

be within 1 standard deviation of the mean.

there is about a 95.44% probability that the actual return will

be within 2 standard deviations of the mean.

There is about a 99.74% probability that the actual return will

be within 3 standard deviations of the mean.

Summary and conclusions

18

average, and mean returns from a sample of returns

data.

We can also do the same for a security’s risk premium.

The mean and standard deviation calculated from

sample returns data are often used as estimates of

expected returns and the risk measure for a security or

for the market as a whole.

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