Chapter 1 An Overview of Managerial Finance - PowerPoint PPT Presentation

Loading...

PPT – Chapter 1 An Overview of Managerial Finance PowerPoint presentation | free to download - id: 6e6e70-ZGQ2Z



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Chapter 1 An Overview of Managerial Finance

Description:

Title: Chapter 1 An Overview of Managerial Finance Author: Susan Cook Last modified by: JEFFREY P. MARANAN Created Date: 1/24/2004 6:24:47 PM Document presentation format – PowerPoint PPT presentation

Number of Views:27
Avg rating:3.0/5.0
Date added: 16 February 2020
Slides: 34
Provided by: SusanC196
Category:

less

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

Title: Chapter 1 An Overview of Managerial Finance


1

Chapter 4 Risk and Rates of Return
2
Defining and Measuring Risk
  • Risk is the chance that an unexpected outcome
    will occur
  • A probability distribution is a listing of all
    possible outcomes with a probability assigned to
    each
  • must sum to 1.0 (100).

3
Expected Rate of Return
  • Rate of return expected to be realized from an
    investment during its life
  • Mean value of the probability distribution of
    possible returns
  • Weighted average of the outcomes, where the
    weights are the probabilities

4
Expected Rate of Return
State of the economy Prob. Martin Product RETURNS Martin Product RETURNS US Electric RETURNS US Electric RETURNS
(1) (2) (3) (4) (2 x 3) (5) (6) (2 x 5)
Boom 0.2 110 20
Normal 0.5 22 16
Recession 0.3 -60 10
E(K)
5
Expected Rate of Return
6
Continuous versus Discrete Probability
Distributions
  • Continuous Probability Distribution number of
    possible outcomes is unlimited, or infinite.

7
Measuring Risk The Standard Deviation Martin
Product
K E(K) K E(K) K E(K)2 Pr. K E(K)2 x Pr
(1) (2) (3) (1 2) (4) (5) (6) (4 x 5)
110 0.2
22 0.5
-60 0.3

8
Measuring Risk The Standard Deviation
9
Measuring Risk Coefficient of Variation
  • Standardized measure of risk per unit of return
  • Calculated as the standard deviation divided by
    the expected return
  • Useful where investments differ in risk and
    expected returns

10
Risk Aversion and Required Returns
  • Risk Premium (RP)
  • The portion of the expected return that can be
    attributed to an investments risk beyond a
    riskless investment
  • The difference between the expected rate of
    return on a given risky asset and that on a less
    risky asset

11
Portfolio Risk and the Capital Asset Pricing Model
  • CAPM
  • A model based on the proposition that any stocks
    required rate of return is equal to the risk-free
    rate of return plus a risk premium, where risk is
    based on diversification.
  • Portfolio
  • A collection of investment securities

12
Portfolio Risk and Return
  • The goal of finance manager is to create
  • AN EFFICIENT PORTFOLIO Maximizes return
  • for a given level of risk or minimizes risk for a
  • given level of return.

13
Portfolio Returns
  • Expected return on a portfolio,
  • The weighted average expected return on the
    stocks held in the portfolio

14
Portfolio Returns
  • Realized rate of return, k
  • The return that is actually earned
  • Actual return usually different from expected
    return

15
Portfolio Risk
  • Correlation Coefficient, r
  • Measures the degree of relationship between two
    variables.
  • Perfectly correlated stocks have rates of return
    that move in the same direction.
  • Negatively correlated stocks have rates of return
    that move in opposite directions.

16
Portfolio size and risk
  • Inc size of a portfolio ? risk dec
  • Risk dec to a certain point .. (Co. risk 0)
  • If we take all sec in the stock mkt as one
    portfolio (max size) ? still some risk exist
    (Market Risk) relevant risk the contribution
    of a secs risk to a portfolio.

17
Portfolio Risk
  • Risk Reduction
  • Combining stocks that are not perfectly
    correlated will reduce the portfolio risk through
    diversification.
  • The riskiness of a portfolio is reduced as the
    number of stocks in the portfolio increases.
  • The smaller the positive correlation, the lower
    the risk.

18
Firm-Specific Risk versus Market Risk
  • Firm-Specific Risk
  • That part of a securitys risk associated with
    random outcomes generated by events, or
    behaviors, specific to the firm.
  • Firm-specific risk can be eliminated through
    proper diversification.

19
Firm-Specific Risk versus Market Risk
  • Market Risk
  • That part of a securitys risk that cannot be
    eliminated through diversification because it is
    associated with economic, or market factors that
    systematically affect all firms.

20
Firm-Specific Risk versus Market Risk
  • Relevant Risk
  • The risk of a security that cannot be diversified
    away, or its market risk.
  • This reflects a securitys contribution to a
    portfolios total risk.

21
NO GOOD
  • .. of thinking how risky a security is if helf in
    isolation you need to measure its market risk
    measure how sensitive it is to market this
    sensitivity is called BETA

22
The Concept of Beta
  • Beta Coefficient, b
  • A measure of the extent to which the returns on a
    given stock move with the stock market.
  • b 0.5 Stock is only half as volatile, or
    risky, as the average stock.
  • b 1.0 Stock has the same risk as the average
    risk.
  • b 2.0 Stock is twice as risky as the average
    stock.

23
Steps in deriving Beta
  • Plot mkt ret (X) and asset ret (Y) at various
    point in time.
  • Regression the slope beta
  • The higher the beta the higher the risk
  • Beta for the market 1, all other betas are
    viewed in relation to this value.
  • Beta may be ve or v, ve is the norm
  • Majority of betas fall between .5 and 2.

24
Portfolio Beta Coefficients
  • The beta of any set of securities is the weighted
    average of the individual securities betas
  • IF mkt ret inc by 10, a port with a beta of .75
    will experience a 7.5 inc in its return (.75 x
    10)

25
The Relationship Between Risk and Rates of Return
26
Market Risk Premium
  • RPM is the additional return over the risk-free
    rate needed to compensate investors for assuming
    an average amount of risk.
  • Assuming
  • Treasury bonds yield 6,
  • Average stock required return 14,
  • Then the market risk premium is 8 percent
  • RPM kM - kRF 14 - 6 8.

27
The Required Rate of Return for a Stock
  • Security Market Line (SML)
  • The line that shows the relationship between risk
    as measured by beta and the required rate of
    return for individual securities.

28
Security Market Line - CAPM
29
The Impact of Inflation
  • kRF is the price of money to a riskless borrower.
  • The nominal rate consists of
  • a real (inflation-free) rate of return, and
  • an inflation premium (IP).
  • An increase in expected inflation would increase
    the risk-free rate.

30
Changes in Risk Aversion
  • The slope of the SML reflects the extent to which
    investors are averse to risk.
  • An increase in risk aversion increases the risk
    premium and increases the slope.

31
Changes in a Stocks Beta Coefficient
  • The Beta risk of a stock is affected by
  • composition of its assets,
  • use of debt financing,
  • increased competition, and
  • expiration of patents.
  • Any change in the required return (from change in
    beta or in expected inflation) affects the stock
    price.

32
Stock Market Equilibrium
  • The condition under which the expected return on
    a security is just equal to its required return
  • Actual market price equals its intrinsic value as
    estimated by the marginal investor, leading to
    price stability

33
Changes in Equilibrium Stock Prices
  • Stock prices are not constant due to changes in
  • Risk-free rate, kRF,
  • Market risk premium, kM kRF,
  • Stock Xs beta coefficient, bx,
  • Stock Xs expected growth rate, gX, and
  • Changes in expected dividends, D0.
About PowerShow.com