risk & retirn 4
Post on 21-Jan-2015
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Risk & Return
Risk is like pornography. It is hard to define but you know it when you see it.
John Wachowicz
Return
• Dividend/ Coupon
Current yield
• Capital gains
• Return = (Divt + ( Pt – Pt-1))/ Pt-1
Risk• Actual return is different from expected return• A random variable subject to a probability
distribution• Possible scenarios• Returns in each of those scenarios• Mean and standard deviation• Attitude towards risk – Risk averse investors• Return and risk in a portfolio context• Systematic and unsystematic risk• Concept of risk premium
Return Variability
A B C
Investment A: noreturn variation,no risk
Investment B: some return variation, somerisk
Investment C:wide returnvariation, muchrisk
4.0% 2.5%
6.00%
15%
-8%
• ..\Copy of Risk_in_FM.xls
1926-2000 Average Annual Std Rate of Return Dev
Treasury Bills 3.9 3.2 Government Bonds 5.7 9.4 Corporate Bonds 6.0 8.6 Common Stocks 13.0 20.2 Small-firm stocks 17.3 33.2
Capital Asset Pricing Model
• The expected risk premium varies in direct proportion to beta.
• The security market line
r = rf + (rm – rf )
• Expected risk premium = beta * expected risk premium on the market
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