Risk & Return.pptx Slides Financial management

Risk & Return.pptx Slides Financial management

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  Topic: Risk andReturn
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  2 Chapter Outline Return –Definition Risk – Definition Actual Return Actual Risk Expected Return Expected Risk
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  3 Defining Return Income receivedon an investment plus any change in market price, usually expressed as a percent of the beginning market price of the investment. Dt + (Pt – Pt - 1 ) Pt - 1 R =
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  4 Return Example The stockprice for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share and shareholders just received a $1 dividend. What return was earned over the past year? $1.00 + ($9.50 – $10.00 ) $10.00 R = = 5%
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  5 Defining Risk What rateof return do you expect on your investment (savings) this year? What rate will you actually earn? The variability of returns from those that are expected. It is calculated by using standard deviation method.
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  6 Actual Return andActual Risk (Example) Periods Returns (X) (X-Mean) (X-Mean)ˆ2 1 0.10 -0.0040 0.000016 2 0.12 0.0160 0.000256 3 0.08 -0.0240 0.000576 4 0.09 -0.0140 0.000196 5 0.13 0.0260 0.000676 ∑ 0.52 0.0000 0.0017 Mean 0.1040 Mean (%) 10.40% S.D 0.0207 S.D (%) 2.07% Actual Retrun Actual Risk
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  7 Determining Expected Return (DiscreteDist.) R = S ( Ri )( Pi ) R is the expected return for the asset, Ri is the return for the ith possibility, Pi is the probability of that return occurring, n is the total number of possibilities. n I = 1
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  8 How to Determinethe Expected Return and Standard Deviation Stock BW Ri Pi (Ri)(Pi) -0.15 0.10 –0.015 -0.03 0.20 –0.006 0.09 0.40 0.036 0.21 0.20 0.042 0.33 0.10 0.033 Sum 1.00 0.090 The expected return, R, for Stock BW is .09 or 9%
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  9 Determining Standard Deviation(Risk Measure) s = S ( Ri – R )2 ( Pi ) Standard Deviation, s, is a statistical measure of the variability of a distribution around its mean. It is the square root of variance. Note, this is for a discrete distribution. n i = 1
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  10 How to Determinethe Expected Return and Standard Deviation Stock BW Ri Pi (Ri)(Pi) (Ri - R )2 (Pi) –0.15 0.10 –0.015 0.00576 –0.03 0.20 –0.006 0.00288 0.09 0.40 0.036 0.00000 0.21 0.20 0.042 0.00288 0.33 0.10 0.033 0.00576 Sum 1.00 0.090 0.01728
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  11 Determining Standard Deviation(Risk Measure) n i=1 s = S ( Ri – R )2 ( Pi ) s = .01728 s = 0.1315 or 13.15%
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  12 Expected Return andExpected Risk (Example) Alternatives Returns (Ri) Probabilities (Pi) Ri*Pi (R-Mean) (R-Mean)^2 (R-Mean)^2*Pi 1 0.10 0.2000 0.0200 -0.0105 0.00011025 0.00002205 2 0.12 0.2500 0.0300 0.0095 0.0000902 0.0000226 3 0.08 0.1000 0.0080 -0.0305 0.00093025 0.0000930 4 0.09 0.1500 0.0135 -0.0205 0.00042025 0.0000630 5 0.13 0.3000 0.0390 0.0195 0.00038025 0.0001141 ∑ 0.52 1.0000 0.1105 -0.0325 0.0003148 Expected Return 0.1105 Expected Return (%) 11.05% Expected Risk 0.0177 Expected Risk (%) 1.77%
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