Part 3 Risk lti aversely h las shsayonge
Part 3 Risk Jilin university College of economics Ding zhaoyong
Outline of this part This part examines the relationship between expected return and risk for portfolios and individual assets. When the capital markets are in equilibrium, they determine a trade-off between expected return and k This part is composed by four chapters: 9 capital market theory: an overview( risk and return 10 CAPM 11 APT 12 risk return and capital budgeting
Outline of this part This part examines the relationship between expected return and risk for portfolios and individual assets. When the capital markets are in equilibrium, they determine a trade—off between expected return and risk. This part is composed by four chapters: – 9 capital market theory: an overview( risk and return) – 10 CAPM – 11 APT – 12 risk ,return and capital budgeting
Chapter 9 Risk and return
Chapter 9 Risk and return
Chapter 9 RisT and return 9.1 Returns Dollar return If you buy some kinks of assets, your gain or loss from that investment is called the return on your investment. This return will usually have tow components. First, you may receive some cash directly while you own the investment. This is called the income component of your return. Second, the value of the asset you purchase will often change. In this case, you have a capital gain or capital loss on your investment. Total dollar return= dividend income +capital gain(loss) Total cash if stock is sold= initial investment+total return
Chapter 9 Risk and return 9.1 Returns – Dollar return If you buy some kinks of assets, your gain or loss from that investment is called the return on your investment. This return will usually have tow components. First, you may receive some cash directly while you own the investment. This is called the income component of your return. Second, the value of the asset you purchase will often change. In this case, you have a capital gain or capital loss on your investment. Total dollar return= dividend income +capital gain(loss) Total cash if stock is sold= initial investment+total return
Chapter 9 Risk and return 5 Percentage return It is usually more convenient to summarize information about return in percentage terms, rather than dollar return, because that way your return does not depend on how much you actually invest. The question we want to answer is: how much do we get for each dollar we invest Percentage return=(dividends paid at end of period+change in market value over period)/beginning market value 9.2 Inflation and returns Real versus nominal returns The returns we calculated in the previous section are called nominal returns because they were not adjusted for inflation
Chapter 9 Risk and return – Percentage return It is usually more convenient to summarize information about return in percentage terms, rather than dollar return, because that way your return does not depend on how much you actually invest. The question we want to answer is : how much do we get for each dollar we invest. Percentage return=(dividends paid at end of period+change in market value over period)/beginning market value 9.2 Inflation and returns – Real versus nominal returns The returns we calculated in the previous section are called nominal returns because they were not adjusted for inflation
Chapter 9 Risk and return 5 Returns that have been adjusted to reflect inflation are called real return The difference between nominal return and real return is important and bears repeating Your nominal return on an investment is the percentage change in the number of dollars you have. Your real return on an investment is the percentage change in how much you can buy with your dollars, in other words, the percentage change in your buying power The fisher effect The fisher effect is the relationship between nominal returns, the real returns, and inflation
Chapter 9 Risk and return Returns that have been adjusted to reflect inflation are called real return. The difference between nominal return and real return is important and bears repeating: Your nominal return on an investment is the percentage change in the number of dollars you have. Your real return on an investment is the percentage change in how much you can buy with your dollars, in other words, the percentage change in your buying power. – The fisher effect The fisher effect is the relationship between nominal returns, the real returns, and inflation
Chapter 9 Risk and return 3 Let R stand for the nominal return and r stand for the real return and h stand for the inflation rate (1+R)=(1+r)×(1+h) 9.3 Average returns: the first lesson Calculating average returns Risk premiums Rate of return on government bonds is the risk-free return because the government can always raise taxes to pay its bills A particularly interesting comparison involves the virtually risk-free return on T-bills and the very risky return on common stocks
Chapter 9 Risk and return Let R stand for the nominal return and r stand for the real return and h stand for the inflation rate. (1+R)=(1+r)×(1+h) 9.3 Average returns: the first lesson – Calculating average returns – Risk premiums Rate of return on government bonds is the risk-free return because the government can always raise taxes to pay its bills. A particularly interesting comparison involves the virtually risk-free return on T-bills and the very risky return on common stocks
Chapter 9 Risk and return 3 The difference between these two returns can be interpreted as a measure of the excess return on the average risky asset. We call this the“ excess” return since it is the additional return we earn by moving from a relatively risk-free investment to a risky one. Because it can be interpreted as a reward for bearing risk, we will call it risk premium. Risk premium is the excess return required from an investment in a risky asset over a risk-free investment So the first lesson is on average risky assets earn a risk premium
Chapter 9 Risk and return The difference between these two returns can be interpreted as a measure of the excess return on the average risky asset. We call this the “excess” return since it is the additional return we earn by moving from a relatively risk-free investment to a risky one. Because it can be interpreted as a reward for bearing risk, we will call it risk premium. Risk premium is the excess return required from an investment in a risky asset over a risk-free investment. So the first lesson is on average risky assets earn a risk premium
Chapter 9 RisT and return 9. 4 The variability of returns: the second lesson Frequency distributions and variability To get started, we can draw a frequency distribution for the common stock returns like the figure What we need to do is to actually measure the spread in eturns. We now want to know how far the actual return deviates from the average in a typical year. In other words. we need a measure of how volatile the future is. The variance and its square root, the standard deviation, are the most commonly used measures of volatility
Chapter 9 Risk and return 9.4 The variability of returns: the second lesson – Frequency distributions and variability To get started, we can draw a frequency distribution for the common stock returns like the figure. What we need to do is to actually measure the spread in returns. We now want to know how far the actual return deviates from the average in a typical year. In other words, we need a measure of how volatile the future is. The variance and its square root, the standard deviation, are the most commonly used measures of volatility
Number oI years 642 10 86420 Returns 55-45-35-25-15-5515253545
Chapter 9 Risk and return Number of years Returns 16 14 12 10 8 6 4 2 0 -55 -45 -35 -25 -15 -5 5 15 25 35 45