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Risk and Return. Introduction. Investment has two aspects: Security Analysis and Portfolio Analysis Security analysis consists of valuation of financial assets. Value is the function of risk and return. Realized risk (ex-ante) and return and Expected Risk and return (ex-post). Return.

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Presentation Transcript
introduction
Introduction
  • Investment has two aspects: Security Analysis and Portfolio Analysis
  • Security analysis consists of valuation of financial assets.
  • Value is the function of risk and return.
  • Realized risk (ex-ante) and return and Expected Risk and return (ex-post)
return
Return
  • Return is the reward of investment such as interest on bonds and dividend on shares.
  • Realized is historical return which already earned.
  • Two components of returns:
    • Yield: The income component of a security in the form of periodic interest or dividend. Yield
    • Capital Gains...
slide4

Capital Gain (loss): The change in price on a security over some period of time or

  • It is the appreciation (depreciation) in the price of the assets known as capital gain (loss)
  • The difference between purchase price and selling price
slide5

Total Return = Yield + Price Change (Capital gain & loss)

  • Where TR = Total Return; = Cash Flow during a period; = Ending Price of Security; = Beginning Price of Security
return relative rr
Return Relative (RR)
  • The total return for an investment for a given time period stated on the basis of 1.0
  • It is used to eliminates negative numbers by adding 1.0 to the total return.
  • RR = TR in decimal form + 1.0
  • TR in decimal form = RR - 1.0
  • E.g., TR of 0.50 have RR of 1.50 and TR of -9.07% (-0.0907) the RR will be -0.0907+1 = 0.9093
cumulative wealth index cwi
Cumulative Wealth Index (CWI)
  • It measures how one’s wealth in rupee changes over time.
  • So it is the accumulation of wealth of series of returns over period.
  • It refers that how much Rs. 1 investment will generate returns over a period.
  • CWIn = WI0 (1+TR1) (1+TR2).........(1+TRn)

OR

  • CWIn = WI0 (RR1) (RR2).........(RRn)
  • Where, CWIn = Cumulative Wealth Index; WI0 = Initial Investment; TR = Total Returns; RR = Return Relative
  • TR is stated in percent or demical; RR on the basis of 1.0 and CW is stated in dollars
taking a global perspective
Taking a Global Perspective
  • While investing globally, investor has to look at the exchange risk (currency risk)
  • Exchange Risk is the adverse impact on the return as a result of fluctuation in currency rates. Or decrease of home currency relative to foreign currency.
  • The fluctuation in currency may be a source of profit and loss.
  • Increase in currency rate lead to profit and vice versa.
formula of calculating currency adjusted returns
Formula of Calculating Currency-Adjusted Returns
  • TR = RR -1
  • If the dividend is zero, then RR = (PE/PB)
  • TR = [(PE/PB) x(C1/C0)] – 1
  • Where,
  • PE = Ending Share Price
  • PB = Beginning Share Price
  • C1 = Ending Value of Domestic Currency
  • C0= Beginning Value of Domestic Currency
statistics for returns
Statistics for Returns
  • Taking the average of series of returns need to be averaged.
  • Two methods of calculating average
    • Arithmetic Mean
    • Geometric Mean
arithmetic mean
Arithmetic Mean
  • The sum of periodic returns divided by number of periods.
geometric mean
Geometric Mean

Geometric mean is the nth root of the product of returns for n years.

Geometric mean = (1+R1)x(1+R2)x(1+R3)1/n – 1

GM = [(1+ 15%) x (1+30%) x (1+ (-12))]1/3 – 1

GM = [(1.15)(1.30)(0.88)] 1/3 – 1

GM = 1.096 – 1

GM = 0.096 or 9.6%

problem with arithmetic mean1
Problem with Arithmetic Mean
  • Arithmetic Mean = 100 + (-50)/2
  • A M = 25%
  • Geometric Mean = [(1+1)(1-0.5)] 1/2 – 1
  • GM = 1 – 1
  • GM = 0%
  • The Arithmetic Mean gives a false value of 25%.