Lecture "Fundamentals of finance management (10/E) - Chapter 5: Risk and rates of return" has contents: Investment returns, probability distributions, standard deviation calculation, investor attitude towards risk,.and other contents. | CHAPTER 5 Risk and Rates of Return Stand-alone risk Portfolio risk Risk & return: CAPM / SML Investment returns The rate of return on an investment can be calculated as follows: (Amount received – Amount invested) Return = Amount invested For example, if $1,000 is invested and $1,100 is returned after one year, the rate of return for this investment is: ($1,100 - $1,000) / $1,000 = 10%. What is investment risk? Two types of investment risk Stand-alone risk Portfolio risk Investment risk is related to the probability of earning a low or negative actual return. The greater the chance of lower than expected or negative returns, the riskier the investment. Probability distributions A listing of all possible outcomes, and the probability of each occurrence. Can be shown graphically. Expected Rate of Return Rate of Return (%) 100 15 0 -70 Firm X Firm Y Selected Realized Returns, 1926 – 2001 Average Standard Return Deviation Small-company stocks Large-company stocks L-T corporate bonds L-T government bonds . Treasury bills Source: Based on Stocks, Bonds, Bills, and Inflation: (Valuation Edition) 2002 Yearbook (Chicago: Ibbotson Associates, 2002), 28. Investment alternatives Economy Prob. T-Bill HT Coll USR MP Recession Below avg Average Above avg Boom Why is the T-bill return independent of the economy? Do T-bills promise a completely risk-free return? T-bills will return the promised 8%, regardless of the economy. No, T-bills do not provide a risk-free return, as they are still exposed to inflation. Although, very little unexpected inflation is likely to occur over such a short period of time. T-bills are also risky in terms of reinvestment rate risk. T-bills are risk-free in the default sense of the word. How do the returns of HT . | CHAPTER 5 Risk and Rates of Return Stand-alone risk Portfolio risk Risk & return: CAPM / SML Investment returns The rate of return on an investment can be calculated as follows: (Amount received – Amount invested) Return = Amount invested For example, if $1,000 is invested and $1,100 is returned after one year, the rate of return for this investment is: ($1,100 - $1,000) / $1,000 = 10%. What is investment risk? Two types of investment risk Stand-alone risk Portfolio risk Investment risk is related to the probability of earning a low or negative actual return. The greater the chance of lower than expected or negative returns, the riskier the investment. Probability distributions A listing of all possible outcomes, and the probability of each occurrence. Can be shown graphically. Expected Rate of Return Rate of Return (%) 100 15 0 -70 Firm X Firm Y Selected Realized Returns, 1926 – 2001 Average Standard Return Deviation Small-company stocks .
