02_Lectureppt Return and risk measures It is important to understand the relation between risk and return so we can determine appropriate risk-adjusted. What is Return?“Income This model states the relationship between expected return, thesystematic return and the valuation of securities. Risk in Portfolio Context. b. Market Risk. Quantified by Beta & used in. CAPM: Capital Asset Pricing Model. Relationship b/w market risk & required return as.
The standard deviation can be calculated from each years portfolio expected return just like for an individual asset. What type of risk does this represent? However there is a limit to the decrease in risk, since most stocks are positively correlated you can not eliminate all of the market risk 37 Calculations of Standard Deviation Variance and Standard Deviation can be calculated if you know the correlation coefficient and standard deviation of each asset. The type of marginal investor plays a key role in determining how a firm may respond to different circumstances Usually it is assumed that the marginal investor is well diversified.
In other words the stock has a higher amount of Non-diversifiable risk. Since the Market risk for the stock is higher it should also have a higher return Bank of America has a beta of 1. An easy way to demonstrate this is to graph the possible risk and return combinations. The slope of the line is then equal to the market risk premium rm-rRF Then you can graph all the possible combinations of risk and return.The relationship between risk and return
The market risk premium measures the risk aversion of the investors. If investors become more risk averse the risk premium widens investors require a higher return to accept risk In this case the slope of the security market line will become steeper.
Bottom Up Beta Comparing the firm to others in the same industry.
The risk-return relationship
Regression -- Attempts to explain the relationship between two variables by estimating the line that best describes the relationship. X is the independent variable and placed on the horizontal axis.
Y the dependent variable and placed on the vertical axis The value of Y depends upon X a is the Y intercept and b the slope of the line.
An R2 of one implies all the points are on the line An R2 of 0. The higher the t-statistic the higher the confidence that we can reject the hypothesis that the slope is zero. If you cannot reject the hypothesis -- It implies that the dependent variable has no impact on the independent variable.
The confidence levels are based upon the number of observations, but in general: If you have a t-statistic above 2. With these low-risk investments you are unlikely to lose money. However, they have a lower potential return than riskier investments and they may not keep pace with inflation.
Learn more about the risks of bonds. Stocks have a potentially higher return than bonds over the long termTerm The period of time that a contract covers.
The Relationship Between Risk and Return
Also, the period of time that an investment pays a set rate of interest. BondBond A kind of loan you make to the government or a company. They use the money to run their operations.
In turn, you get back a set amount of interest once or twice a year. If you hold bonds until the maturity date, you will get all your money back as well.
As a shareholderShareholder A person or organization that owns shares in a corporation. May also be called a investor. But if the company is successful, you could see higher dividends and a rising shareShare A piece of ownership in a company. But it does let you get a share of profits if the company pays dividends.
The Relationship Between Risk and Return - ppt download
Some investments, such as those sold on the exempt market are highly speculative and very risky. They should only be purchased by investors who can afford to lose all of the money they have invested. DiversificationDiversification A way of spreading investment risk by by choosing a mix of investments.
The idea is that some investments will do well at times when others are not.