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FFM_Risk & Return Tutorial

The document covers key concepts in risk and return, including calculations of realized return, risk premium, and portfolio risk. It discusses the importance of beta in measuring market risk and introduces the Capital Asset Pricing Model (CAPM). Additionally, it provides examples of stock comparisons and portfolio management strategies.

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thienvo.hids
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6 views

FFM_Risk & Return Tutorial

The document covers key concepts in risk and return, including calculations of realized return, risk premium, and portfolio risk. It discusses the importance of beta in measuring market risk and introduces the Capital Asset Pricing Model (CAPM). Additionally, it provides examples of stock comparisons and portfolio management strategies.

Uploaded by

thienvo.hids
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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RISK AND

RETURN
Tutorial
TA K E 1 5 M I N S T O R E V I E W T H I S N O T E S
• Calculation of realized return, dividend yield, capital gain and annualized rates.
• Nominal rate vs real rate
• Expected (mean) return calculation with probability distribution
• Risk premium (expected rate – risk-free rate): the compensation rate for
“extra” risk taken by securities holders
• Common way to measure risk is variance and standard deviation which
measure the volatility of securities.
• Calculation of portfolio’s risk & return including weight, securities’ risks,
returns and covariance; correlation coefficient.
• Only specific (unsystematic) risk can be diversified, systematic risk
cannot
•  beta measures market risk of a security/ portfolio indicating sensitivity of the
security’s return to market return.
• CAPM: Expected return = risk-free rate (RFR) +  x (market return –
RFR)
• (Market return – RFR) = market risk premium
QUESTION 1

Standar
• A & D: A dominates when having lower risk,
Expecte higher return
d
Stock d
Deviatio
Return
n
• D & E: no stock dominates, either can be
chosen depending on investor’s risk preference
A 20% 10% • B & E: E dominates when having lower risk,
B 30% 50% higher return
C 15% 12% • A & F, E & F, C & D: no stock dominates as all
D 20% 15% follows the “higher risk, higher return” rule
E 35% 40%
F 25% 15%
QUESTION 3

Compan # shares Expected Weight x


Price Value Weight
y issued Return Return

$
D 20% 8% 1.6%
1,000,000 2.00 2,000,000

$
E 40% 10% 4.0%
500,000 8.00 4,000,000

$
F 40% 21% 8.4%
1,600,000 2.50 4,000,000

Total Value Market return 14.0%


10,000,000

CAPM of stock E: 10% = 4% + E (14% - 4%)


E = 0.6
QUESTION 5
Portfolio is equally risky to the market => portfolio beta = 1, and
portfolio value is $1m. Risk free assets has beta equal to 0.
So we have:
wD = ; wE =
1 = 0.21 x 0.85 + 0.32 x 1.2 + 1.35 x wC => wc = 0.3241
so we will invest $324,100 into stock C
So the investment made into risk-free assets is
1,000,000 – 210,000 – 320,000 – 314,100 = 145,926
QUESTION 6
Expected return of Stock I = probability x distrusted return = 20,5%
CAPM of stock I = 20,5 = 4 + 8* , so  = 2.06
To measure the stock’s volatility (total risk), variance and std need
to be calculated
Variance of stock I:
2 = 0.25 x (0.11 – 0.205)2 + 0.5 x (0.29 – 0.205)2 + 0.25 x (0.13 –
0.25)2
= 0.00728 => standard deviation  = = 0.0853 = 8.53%
Similarly,  of stock II is 0.63,  = 33.96%
 of stock I is much higher  of stock II indicating that stock I has
more systematic risk. On the other hand, the overall risk of stock II is
much higher when its std is 33.96% compared to std of stock I.
Because of higher systematic risk, stock I will have more required
rate of return suggested by CAPM.
QUESTION 10
After sell 45%, you will have 55% of your investment remained in
the restaurant.

Assume 45% of your portfolio will be equally invested in stock and


bond which is 22,5% for each security.

The portfolio return then will be:

wrestaurant x E(r)restaurant + wstock x E(r)stock + wbond x E(r)bond

= 0.225 x 0.08 + 0.225 x 0.12 + 0.55 x 0.15 = 0.1275 = 12.75%


QUESTIONS?

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