risk & return ~ full (1)

8/3/2019 Risk & Return ~ Full (1)

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RISK AND RETURNS

GROUPMEMBERS:

1. MARIAMOHDSALLEH

2. NORAFIDAHMOHDHASHIM

3. AMYROSYILAROMLI

4. FARIDAHHANIMISMAIL


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Outline1. TypesofReturns2. TypesofInvestors

3. Actualvs.ExpectedReturns4. MeasurementofRisks5. Portfolio

6. Diversification7. Capitalassetpricingmodel(CAPM)8. Thesecuritymarketline(SML)


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INTRODUCTION One of the most important concepts in

investment theory is the relationshipbetweenriskandreturn.

The investors are exposed to risk inparticular investment with uncertainexpectedreturns.

Investing in stock market is most riskierthan investing in fixed income such asbondandshorttermfinancial.


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RISK

Risk is defined as situation where thepossibilityofnotachievingtheexpectedvalue.

Or can be define as the probability of

uncertain future outcomes and possibility oflosses

The value of the risk is different betweenactual return and expected return from theinvestment.

The higher different between actual andexpectedvaluethehighertheriskis.


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There are 3 types of returns:

I. Actual return or holding periodreturnII. Expected return or average returnIII. Required return

TYPES OF RETURNS


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TYPES OF RETURNSI. Actual Return Or Holding Period Return

Actual return is what investors actually receive fromtheirinvestments.

Actual return should not be confused with expectedreturn,which is theprojectedreturnonan investmentbased on significant performance combined withforecastmarkettrends.

Theformulaforactualreturnis:Forinstance,theactualreturnonastockpurchasedat$100whosevalueattheendofoneyearis$120issaidtohaveareturnof$120-$100=$20or20%($20/$100).

(endingvalue-beginningvalue)/beginningvalue=actualreturn


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II. Expected Return Or Average ReturnThereturnthatinvestorsnormallyfeelabletoachievedfromtheinvestment

Althoughthisiswhattheinvestorsexpectthereturntobe,thereisnoguaranteethatitwillbetheactualreturn.

Thedifferencebetweenactualandexpectedreturnisduetosystematicandunsystematicrisk.


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Thedisparitybetweentheactual

returnandexpectedreturnonan

investmentprovidesananalyticalframeworkinwhichtounderstandthereasonswhyaninvestmentperformedasitdid,orwhyitperformeddifferentlythanexpected.


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TYPES OF RETURNS

III. Required Return

Is the minimum return required by theinvestor in order for them to commit thedollarsinvestmentintouncertainfuture.

The expected rate of return must behigher than the required rate of returnbeforeinvestorswillparticipate.


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TYPES OF INVESTORS

Three Types Of Basic Investors:I. Risk Averse InvestorsII. Risk- Seeking Or Risk loversIII.Risk- Indifferent ( Neutral )Investors


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The Risk-Averse investors TheInvestorareverymuchcautionabout

theriskthereforetheywillstayawayfromaddinghigh-riskstocksor investments to

their portfolio and in turn will oftenloseoutonhigherratesofreturn.

Investors looking for "safer" investments

will generally stick to index funds andgovernmentbonds,whichgenerallyhavelowerreturns.


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Risk Seekers or Risk LoversAttractedtorisk,meaninganinvestmentwithalowerexpectedreturnbutgreaterrisk

Asthelevelofriskincrease,theinvestorsdont

havetorequireadditionalreturnsforadditionalrisk.

Risk- Indifferent (Neutral ) InvestorsInsensitive to risk investors who are not very

muchconcernsabout theriskas longas there aresomereturns.


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Measurement ofReturn

Holding Period Return (HPR) or alsoknown as Actual Return Expected return

Average returnExpected return based on Probability

Required rate of return


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ACTUAL RETURN

(HOLDING PERIOD RETURN OR HPR)

Holdingperiodreturnisaverybasicwaytomeasurehowmuchreturnyouhaveobtainedon

aparticularinvestment.


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HPR Formula

Rit = (Pt

Pt-1 + Dt)Pt-1Where,

Rit = Return for stock i at period t

(current period)

Pt = Price of a stock i at period t(current period)

Pt-1 = Price of a stock i at period t-1(previous period)

Dt = Dividend paid at current period


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Calculating HPR (Actual Return)

PERIOD PRICE(P) DIVIDEND (Dt) HPR (Ri %)

1989 3.251990 3.2 0.1 1.541991 3.3 0.13 7.191992 3.45 0.12 8.181993 3.5 0.15 5.81994 3.41 0.15 1.711995 3.14 0.11 -4.691996 3.25 0.1 6.691997 3.3 0.16 6.46


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Cont.

Rit = (3.2 3.25 + 0.1)3.25

= 0.0154= 0.0154 x 100=1.54%


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Expected (Average Return)

E (R) = Sum of holdings period return (HPR)Number of holding period

E (R) = R1 + R2 + R3 + R4 + R5 + R6 + R7 + R8N

E (R) = 1.54 + 7.19 + 8.18 +5.80 + 1.71 -4.69 +6.69 +6.468= 4.11%


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Expected Return based on Probability

E (R)= Expected return is the average of aprobability distribution of possiblereturns, calculated by using the followingformula:

R (s) = return from investment subject tovarious economic scenario

P (s) = probability of associated with return


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Returns associated with Probability

StateoftheProbability

associated Returnfrom P(s)xR(s)

economy(s) withreturn(P)investment(R)(%)

Great 0.2 25 5%Good 0.4 15 6%

So-So 0.3 5 1.50%

Bad 0.1 -5 -0.50%

P=1 R=40

(R)=P(s)xR(s)=12%E (R) = 0.2 (25%) + 0.4 (15%) + 0.3 (5%) + 0.1 (-5%)

= 12%


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Measurement

of

Risk


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RISK

Probabilityofincurringharm

Forinvestors,riskistheprobability

ofearninganinadequatereturn. Ifinvestorsrequirea10%rateofreturn

onagiveninvestment,thenanyreturnlessthan10%isconsideredharmful.


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Differences in Levels of Risk - Illustrated

ProbabilityOutcomesthatproduceharm Thewidertherangeofprobable

outcomesthegreatertheriskoftheinvestment.

AisamuchriskierinvestmentthanB

Possible Returns on the Stock-30% -20% -10% 0% 10% 20% 30% 40%


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STANDARD DEVIATION

(Ri E (R))

Where,E(R) = expected return for stock IR it = actual return for stock i at period t


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EXAMPLE 3

Usingtheinformationfromtableabove,calculatedthestandarddeviation.

PERIOD PRICE(P) DIVIDEND(Dt) HPR(Ri%)

1989 3.25 1990 3.2 0.1 1.541991 3.3 0.13 7.191992 3.45 0.12 8.181993 3.5 0.15 5.81994 3.41 0.15 1.711995 3.14 0.11 -4.691996 3.25 0.1 6.691997 3.3 0.16 6.46


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(Ri E (R))

=1/8-1

=4.32%

[(1.544.11)+(7.194.11)+(8.18-

4.11)+(5.804.11)+(1.714.11)+(-4.694.11)+(6.694.11)+(6.464.11)]


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Portfolio

Themonetaryreturnexperiencedbyaholderofaportfolio.Portfolioreturnscan

becalculatedonadailyorlong-term

basistoserveasamethodofassessingaparticularinvestmentstrategy.Dividendsandcapitalappreciationarethemain

componentsofportfolioreturn.

http://www.investopedia.com/terms/p/portfolio\return


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Portfolio Return

Theexpectedreturnofaportfolioisaweightedaverageoftheexpectedreturnof

individualassetsintheportfolio.

PortfolioReturn(Rp)=WiE(Ri)Where,E(Ri) =expectedreturnofassetiintheportfolioWi =proportionofinvestmentinparticularasseti


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Example 1

Assume thatyouhaveRM10,000andwanted toinvestRM5,000inthestockmarketandanotherRM5,000 in bond market. If the expected returnfromthestockmarketandbondmarketare15%and8%respectively,theportfolioreturn(Rp)is:

Rp = Wi E (Ri)= Ws Rs + Wb Rb= (5000/10000) x 15% +(5000/10000)x 8%= 0.5= 11.5%


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Example 2

AhmadisconsideringofbuyingMaybankandMaxis

sharesfromKLSE.BelowaresomeoftheinformationavailableforMaybankandMaxis.

Maybank Maxis

Expected return 8% 12%

Proportion of investment 0.40 0.60

What is the expected portfolio return?Rp = WMb RMb + WMax RMax

= 0.40( 8%) + 0.60 (12%)= 10.4%


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Variability of its return Investors had a tool that they coulduse to dramatically reduce the riskof the portfolio without a significantreduction in the expected return ofthe portfolio.

Portfolio Risk


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CONT.

Where,p =theportfoliovarianceWA=proportionofinvestmentinassetA

WB=proportionofinvestmentinassetB

A =thevarianceofreturnA=thevarianceofreturnBAB = correlationcoefficientbetweenAandB

))()()()((2)()()()(,

2222

BABABABBAAp wwww

risk & return ~ full (1)

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