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Chapter 2 FUNDAMENTALS OF RISK AND RETURN

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What is investment risk and how is it measured? How are risk and return measured for ... Figure 2.5 Monthly Returns for Dow Chemical and Verizon Communication ... – PowerPoint PPT presentation

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Title: Chapter 2 FUNDAMENTALS OF RISK AND RETURN


1
Chapter 2 FUNDAMENTALS OF RISK AND RETURN
  • What are the sources of investment returns?
  • How are investment returns measured?
  • What is investment risk and how is it measured?
  • How are risk and return measured for portfolios
    of assets?
  • Why does diversification benefit investors?
  • What is the relationship between risk and
    required return?

2
Sources of investment returns
  • Income
  • Interest
  • Dividends
  • Price changes Capital gains or Capital losses
  • Paper gains and losses
  • Ex-ante and ex-post returns

3
Measuring investment returns
  • Calculating holding period returns
  • Breaking down returns between income and capital
    gains
  • Calculating expected returns
  • Inflation adjusted returns
  • International returns
  • Total return indexes

4
Investment History The Agony of Bond
Investors 1965-1981
5
Figure 2.1 Total Return Index for Johnson
Johnson 1991-2001
6
Summarizing returns
  • Arithmetic mean
  • Annualizing the arithmetic mean
  • Geometric mean
  • Comparing the geometric and arithmetic means

7
Investment risk
  • A definition of risk uncertainty of return
  • Types (sources) of risk
  • Default, Credit, Tax, Interest Rate, Market,
    Event, Liquidity, Foreign Exchange
  • Measuring risk
  • Calculating a standard deviation
  • Annualizing a standard deviation

8
Figure 2.2 Probability of Possible Return
9
Figure 2.3 Stock and T-Bill Returns
1982-2001
10
Figure 2.4 Monthly Returns for 3M and
Starbucks
11
Risk, return and investment selection
  • Portfolio risk and return
  • Finding the mean return of a portfolio
  • Finding the standard deviation of a portfolio
  • Correlation coefficient

12
Figure 2.5 Monthly Returns for Dow Chemical and
Verizon Communication
13
Diversification
  • Naïve versus efficient diversification
  • Diversifiable versus non-diversifiable risk
  • Diversifiable or unsystematic risk
  • Non-diversifiable or systematic risk
  • Beta
  • Risk and required return

14
Figure 2.6 Real and Nominal Returns on
T-Bills 1981-2001
15
Figure 2.7 Yields on T-Bills, T-Bonds, and
Baa Corporate Bonds 1988-2002
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