Chapter 2 Measuring Return and Risk - PowerPoint PPT Presentation

Loading...

PPT – Chapter 2 Measuring Return and Risk PowerPoint presentation | free to download - id: 29f97e-ZDc1Z



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Chapter 2 Measuring Return and Risk

Description:

Returns based on a time series of historical data. Investment decisions largely based on ... defined as unanticipated changes in prices and cash flows over time. ... – PowerPoint PPT presentation

Number of Views:44
Avg rating:3.0/5.0
Slides: 29
Provided by: davidpec
Learn more at: http://www.csb.uncw.edu
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Chapter 2 Measuring Return and Risk


1
Chapter 2Measuring Return and Risk
  • Measuring Returns
  • Measuring Risk
  • Distributions

2
Learning Objectives
  • Sources of Investment Returns
  • Measures of Investment Returns
  • Sources of Investment Risk
  • Measures of Investment Risk
  • Monte Carlo Simulation
  • Investment Performance and Margin

3
Sources of Investment returns
  • Dividends, Interest
  • Cash dividends on common, preferred stock
  • Interest (coupons) on Bills and Bonds
  • Capital gains/losses (Realized vs. Paper)
  • Increases/decreases in price
  • Other
  • Stock Dividends
  • Rights and Warrants

4
Returns on Investment
  • Ex Ante Returns
  • Returns derived from a probability distribution
  • Based on expectations about future cash flows
  • Ex Post Returns
  • Returns based on a time series of historical data
  • Investment decisions largely based on ex post
    analysis modified by ex ante expectations

5
Measuring Returns
  • Holding Period Returns (HPR) Eq. 2-1

Where Pt current price Pt-1 purchase
price CFt cash flow received in time t HPR
normally computed on monthly basis
6
Measuring Returns
  • Holding Period Return Relative (HPRR) Eq. 2-2
  • HPR HPRR - 1

7
Measuring Returns
  • Per-Period Return (PPR) Eq. 2-3
  • Return earned for particular period (for example,
    annual return)
  • Per-Period Return (Periods Income Price
    Change) ? Beginning Period Value
  • Per-Period Return Relative (PPRR) Eq. 2-3a
  • Per-Period Return Relative (Periods Income
    End of Period Value) ? Beginning Period Value
  • PPR PPRR - 1

8
Compounding
  • Computing Future Values given a ROR
  • FV Begin Value (1 ROR)t Eq. 2-4
  • Where t number of periods
  • ROR assumed Rate of Return
  • (1 ROR)t Future Value Interest Factor (FVIF)
  • FV is also termed Ending Value
  • Example What is the future value of 10,000
    invested for 10 years if the ROR is 8?
  • FV 10,000 (1.08)10 21,589.25

9
Compounding
  • Computing the Effective Annual Rate
  • Rear (1 HPR)12/n -1
  • Example You realize a 6.5 return over a 4 month
    period. What is the EAR
  • (1.065)12/4 - 1 0.2079 20.79 per annum

10
Measuring Average Returns
  • Average Rate of Return (AROR) as Arithmetic
    Average

11
Measuring Geometric Returns
  • Geometric Returns as Product (P)

GHPR as a mean geometric holding period
return Arithmetic Average Returns upwardly biased
12
Expected Returns
  • Probability Distributions
  • Normal
  • Leptokurtic
  • Platykurtic
  • Skewed
  • Expected Returns are State of Nature specific
    probability assignments

13
Portfolio Expected Returns
  • Weighted Average Rate of Return
  • WARR W1 x E(R1) W2 x E(R2) . . . Wn x
    E(Rn)
  • where Wi of portfolio invested in security i
  • E(Ri) expected per-period return for security i
  • Subject to W1 Wn 1

14
Risk and return
  • What is risk?
  • Uncertainty - the possibility that the actual
    return may differ from the expected return
  • Probability - the chance of something occurring
  • Expected Returns - the sum of possible returns
    times the probability of each return

15
Types of Risk
  • Pure Risk
  • Involves only chance of loss or no loss
  • Casualty insurance is a good example
  • Moral Hazard Problem
  • Adverse Selection
  • Speculative Risk
  • Associated with speculation in which there is
    some chance of gain and some chance of loss

16
Sources of Risk
  • Investment Theory Market Risk
  • Diversifiable vs. Non-Diversifiable (CAPM)
  • Purchasing Power impact of inflation
  • Real vs. Nominal Returns
  • Interest Rate Risk
  • Changes in market values when rates change
  • Price risk vs. Reinvestment Rate Risk

17
Sources of Investment Risk
  • Business Risk (non-systematic)
  • Financial Risk
  • Default, Liquidity, Marketability, Leverage
  • Exchange Rate Risk Political Risk
  • Tax Risk (changes in code, treatment)
  • Investment Manager Risk
  • Additional Commitment Risk

18
Measures of Risk
  • Standard Deviation
  • Coefficient of Variation CV SD / Mean
  • Beta (CAPM relative risk market)
  • Range highest to lowest expected values
  • Semi-Variance (trimmed mean)

19
Measuring Risk
  • Finance
  • Standard Deviation (SD)

20
Risk and Return
  • Fundamental Relationship
  • The greater the risk, the greater the expected
    return (positively related)
  • Investors assumed to be risk averse
  • The will want the same return with less risk.
  • Assume greater risk only for greater returns.
  • Risk and Return relationship varies over time.

21
Monte Carlo Simulation
  • Dealing with random nature of returns
  • Use of random numbers (probabilities) to vary
    expected future outcomes.
  • Computer programs will generate numbers between 0
    and 1. Output range can be set
  • Example only values between 0 and .25
  • Random effects may be positive or negative
    (requires two draws)

22
Investment Leverage Buying on Margin
  • Buying on Margin
  • Margin rate percentage of securities purchase
    that must come from investors funds rather than
    from borrowing
  • Initial margin rate used when determining cash
    needed for new purchase
  • Maintenance margin rate used when determining if
    margin call is needed

23
Investment Leverage Buying on Margin
  • Margin Rates
  • Federal Reserve Board vs. In-house rule
  • Regulation T
  • 50 initial margin rate
  • NYSE's Rule 431 FINRA's Rule 2520
  • 25 maintenance margin rate MMR
  • 30 on short positions
  • In-house requirements may be higher, never lower

24
Investment Leverage Buying on Margin
  • Buying Power
  • Dollar value of additional securities that can be
    purchased on margin with current equity in margin
    account
  • BP a function of Net Equity position
  • E MV Loan
  • BP (E / IMR) MV
  • See examples 1 and 2 on page 2.44-.45

25
Investment Leverage Buying on Margin
  • Margin Calls
  • M/C Threshold Loan Value / (1 MMR)
  • Example MMR 25, Loan 50,000
  • M/C T 50,000 / (.75) 66,667.
  • If value of portfolio drops below 66,667
    broker calls for Cash Required Loan
    MV(1-MMR)
  • Meeting Margin calls
  • Deposit (or transfer additional funds)
  • Liquidate a portion of portfolio proceeds to
    pay down

26
Investment Leverage Buying on Margin
  • Effects of Margin Buying on Investment Returns
  • ROI (Sell Buy) / Buy
  • ROI (50000 40000) / 40000 25
  • 50 Margin (50000 40000) / 20000 50
  • ROI (50000 60000) / 60000 - 16.66
  • ROI (50000 60000) / 30000 - 33.33

27
Investment Leverage Buying on Margin
  • Broker Call-Loan Rate
  • Interest rate charged by banks to brokers for
    loans that brokers use to support their margin
    loans to customers
  • Usually scaled up for margin loan rate

28
Take-Home Exercise
  • Mini-case starting page 2.54
About PowerShow.com