Risk and Return - Lecture 1

7/21/2019 Risk and Return - Lecture 1

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Financial Mangement (FIN306)

Risk and Return

Chapter 8

Dr. Ishtia !hmad

Department Of Banking and Finance
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Page 2

What is Return

What is Risk

Relationship Between Risk andReturn

How to calculate Return

Historical Return and Risk A Case

Study

Microsoft Vs. Walreens

Lecture Outline
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The gain or loss of a security in a particularperiod, the return consists of the income and thecapital gains relative on an investment. It isusually quoted as a percentage.

Performance analysis of an investment requiresinvestors to measure returns over time.

Return and risk being intricately related, returnmeasurement helps in the understanding of

investment risk.

(Financial) Return


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Page 4

ncertainty of outcome !!!

Risk can be defined as a measure of the uncertainty in aset of potential outcomes for an event in which there is a

chance of some loss.

Risky " Potential for loss e#ists

It is important to measure and analy$e the riskpotential of an investment, so as to make aninformed decision.

(Financial) Risk


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Investments must be analy$ed interms of, both, their return potential aswell as their riskiness or variability.

%istorically, its been proven thathigher returns are accompanied by

higher risks.

&'(

The

Risk-and-Return Trade-off


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Dollar Profits and Percentage Returns

)ollar Profit or *oss " +nding value )istributions ' -riginal ost

Rate of return " )ollar Profit or *oss

-riginal ost

Holding Period Return (HPR) " Profit/*oss ost

HPR " +nding price )istributions ' 0eginning price0eginning price


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Powerpoint Templates Page 7

alculating dollar and percentage returns!

1oe bought some gold coins for 23,444 and sold them 5 months later for 23,644.

1ane on the other hand bought 344 shares of a stock for 234 and sold those 6 years later for236 per share after receiving 24.(4 per share as dividends for the year.

alculate the dollar profit and percent return earned by each investor over their respectiveholding periods.

Solution:

Joes Dollar Profit !nding "alue # $riginal cost

" 23,644 ' 23,444 " 26442644

Joes HPR Dollar %rofit & $riginal cost

" 2644/23,444 " 647647

Janes Dollar Profit '!nding "alue (Distri)utions* + $riginal ,ost " 236 # 344 24.(4 # 344 ' 234 # 344

" 823,644 2(49 ' 23,444

" 26(4.4426(4.44

1ane:s HPR " 26(4.44/23,444 " 6(76(7

Dollar Profits and Percentage Returns +#ample


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Powerpoint Templates Page -

,alculating .PR and !.R/

1oe bought some gold coins for 23,444 and sold them 5 months later for 23,644.1ane on the other hand bought 344 shares of a stock for 234 and sold those 6 years later for 236 per share afterreceiving 24.(4 per share as dividends for the year.

alculate the dollar profit and percent return earned by each investor over their respective holding periods.

Solution:

Joes 0PR " 647647;PR" %PR/n" 4.64/4.3/n '3" 834.649> 3/4.3/n '3 " 834.6(9> @ '3 "+;R " 83%PR9>3/n '3 " 834.6(9> @ '3 "

33.&733.&7

Returns at sae ootings 'annualied* +#ample


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Powerpoint Templates Page

Aicrosoft Bs. Calgreens

Rate of return for both companies are given from644? to 6436

0ased on the Risk and return analysis in which

stock you will like to invest!!!!/

Historical Return and Risk A Case Study


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Bariance and standard deviation are measures ofdispersion

%elps researchers determine how spread out orclustered together a set of numbers or outcomes is

around their mean or average value. The larger the variance, the greater is the variability and

hence the riskiness of a set of values.

ariance and Standard De"iation as a easure of Ris8


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Aicrosoft Bs. Calgreens

Historical Return and Risk A Case Study cont.

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Investment rule number 1:

If faced with 2 investment choices having the same expected returns,

select the one with the lower expected risk.

Investment rule number 2:

If two investment choices have similar risk profiles, select the one with

the higher expected return.

To a9iie return and iniie ris8 , it would be ideal to select an investment that has

a higher e#pected return and a lower e#pected risk than the other alternatives.

Realistically, higher e#pected returns are accompanied by greater variances and thechoice is not that clear cut. The in"estors tolerance for and attitude

toards ris8 atters;

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Risk and Return - Lecture 1