Chapter 2
Download
1 / 12

CHAPTER 2 - PowerPoint PPT Presentation


  • 125 Views
  • Uploaded on

CHAPTER 2. Risk and Return. Topics in Chapter 2. Basic return measurement Types of Risk addressed in Ch 2: Stand-alone (total) risk Portfolio (market) risk (Later, in Chapters 10 & 13, we consider within-firm risk) Relationship between risk and return: CAPM/SML. Investment Returns.

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about ' CHAPTER 2' - maurilio-nihill


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Chapter 2

CHAPTER 2

Risk and Return


Topics in chapter 2
Topics in Chapter 2

  • Basic return measurement

  • Types of Risk addressed in Ch 2:

    • Stand-alone (total) risk

    • Portfolio (market) risk

    • (Later, in Chapters 10 & 13, we consider within-firm risk)

  • Relationship between risk and return: CAPM/SML


Investment returns
Investment Returns

  • Returns may be: actual or expected.

  • Returns can be expressed in: dollars or percentage.

  • Returns include changes in asset value.


What is investment risk
What is investment risk?

  • Risk exists any time returns are not known with certainty.

  • Why is risk important?


Stand alone risk
Stand-Alone Risk

  • Stand-alone (total) risk is the risk facing an investor (firm) who owns only one asset.

  • Measures of stand-alone risk:

    • Standard deviation

    • Variance

    • Coefficient of variation (CV)


Adding stocks to a portfolio
Adding Stocks to a Portfolio

  • What happens to the average return of a one-stock portfolio as additional stocks are included?

  • What happens to the risk of a one-stock portfolio as additional stocks are included?


S 1 stock 35 s many stocks 20
s1 stock ≈ 35%sMany stocks ≈ 20%


Risk vs number of stock in portfolio

p

Company Specific (Diversifiable) Risk

35%

Stand-Alone Risk, p

20%

0

Market Risk

10 20 30 40 2,000 stocks

Risk vs. Number of Stock in Portfolio


Stand alone risk market risk diversifiable risk
Stand-alone risk = Market risk + Diversifiable risk

  • Market risk is that part of a security’s stand-alone risk that cannot be eliminated by diversification.

  • Firm-specific, or diversifiable, risk is that part of a security’s stand-alone risk that can be eliminated by diversification.


Beta

  • Market risk is measured by beta.

  • Beta indicates:

    • A stock’s contribution to the risk of a diversified portfolio

    • The stock’s volatility relative to the market:

      beta > 1.0 high risk

      beta = 1.0 average risk

      beta < 1.0 low risk


Using a regression to estimate beta
Using a Regression to Estimate Beta

  • To estimate a stock’s beta, plot the stock’s returns on the Y axis and market returns on the X axis.

  • The slope of the line of best fit as estimated through regression is the stock’s beta coefficient, or b.


Use the sml to calculate an asset s required return
Use the SML to calculate an asset’s required return.

  • The Security Market Line (SML) is part of CAPM. The equation for the SML is:

  • ri = rRF + (RPM)bi

    • ri is the required return on security i

    • rRF is the risk-free interest rate

    • RPM is the risk premium on the market

    • bi is the beta for security i


ad