Chap 7: RISK AND RETURN

1. Realized Return (Already occurred):

𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝒈𝒂𝒊𝒏 + 𝑫𝒊𝒗𝒊𝒅𝒆𝒏𝒅(𝒐𝒓 𝑪𝒐𝒖𝒑𝒐𝒏)
𝑹𝒆𝒂𝒍𝒊𝒛𝒆𝒅 𝒓𝒆𝒕𝒖𝒓𝒏 =
𝑰𝒏𝒊𝒕𝒊𝒂𝒍 𝒔𝒉𝒂𝒓𝒆 𝒑𝒓𝒊𝒄𝒆(𝒐𝒓 𝒃𝒐𝒏𝒅 𝒑𝒓𝒊𝒄𝒆)

2. Expected Return:
- the rate of return expected to be earned from an investment.
- Based on the probabilities of possible outcomes.
𝒏

𝑬(𝑹) = ∑ 𝒑𝒊 × 𝑹𝒊 = 𝒑𝟏 × 𝑹𝟏 + 𝒑𝟐 × 𝑹𝟐 …
𝒊=𝟏
where 𝑅𝑖 : possible return of state i
𝑝𝑖 : probability of occurrence for 𝑅𝑖

3. Risk premium: The level of risk and required rate are directly related: investors require
higher rates of return for increased risk.
- The “extra” return earned for taking on risk
- US Treasury bills are considered as risk free asset
- The risk premium is the return over and above the risk-free rate investment.

4. Measuring Risk:
- Risk: the variability of return
- Variance and Standard Deviation measure the volatility of asset returns (The greater the
volatility, the greater uncertainty →risker)
a. Dạng 1: Đề ko cho probability mà cho return theo các năm
𝑻
𝟏
̅ )𝟐
𝑽𝒂𝒓 = ∑(𝑹𝒕 − 𝑹
𝑻
𝒕=𝟏
Example: Suppose a particular investment had returns of 10%, 12%, 3% and -9% over
the last 4 years. Compute the average return, variance and standard deviation.
Actual Return (1) Average Return (2) Deviation (1) – (2) Squared Deviation
0.1 0.04 0.06 0.0036
0.12 0.04 0.08 0.0064
0.03 0.04 -0.01 0.0001
-0.09 0.04 -0.13 0.0169
Total 0.16 0.027
Variance = 0.027/4 = 0.00675 and Standard Deviation = √𝑉𝑎𝑟 = √0.00675 = 0.0822

b. Dạng 2: Cho probability

𝒏

𝑽𝒂𝒓𝒊𝒂𝒏𝒄𝒆 = ∑ 𝒑𝒊 × [𝒓𝒊 − 𝑬(𝑹)]𝟐

𝒊=𝟏

KHANH VY 1
 Example: ABC stock has the following probability distribution:
Probability Return
0.25 8%
0.55 10%
0.20 12%

What are its expected return and standard distribution?

Expected Return: 𝐸(𝑅) = 0.25 × 8% + 0.55 × 10% + 0.20 × 12% = 9.9%
𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 0.25 × (8% − 9.9%)2 + 0.55 × (10% − 9.9%)2 + 0.20 ×
(12% − 9.9%)2 = 0.000179
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 = √0.000179 = 1.34%
5. Portfolio Risk & Return:
- A collection of assets
- The risk-return trade-off for a portfolio is measured by the portfolio expected return and
standard deviation, just as with individual assets.
- Portfolio weights: the proportion of the total investment in the portfolio invested in each
asset.
Example: Suppose you have $15,000 to invest and you have purchased securities in the
following amounts. What are your portfolio weights in each security?

2000
⦁ $2,000 of VCB → 𝑊𝑉𝐶𝐵 = 15000 = 0.133
3000
⦁ $3,000 of HAG → 𝑊𝐻𝐴𝐺 = 15000 = 0.2
4000
⦁ $4,000 of KDC → 𝑊𝐾𝐷𝐶 = 15000 = 0.267
6000
⦁ $6,000 of VNM → 𝑊𝑉𝑁𝑀 = 15000 = 0.4

- Portfolio expected return:

𝒎

𝑬(𝑹𝑷 ) = ∑ 𝒘𝒋 × 𝑬(𝑹𝒋 )
𝒋=𝟏
Example:
State Probability Stock A Stock B
Boom 0.25 15% 10%
Normal 0.60 10% 9%
Recession 0.15 5% 10%
What are the expected return and standard deviation for a portfolio with an investment of
$6,000 in stock A and $4,000 in stock B? → 𝑤𝐴 = 60% 𝑎𝑛𝑑 𝑤𝐵 = 40%

Cách 1: each asset (ko dùng để tính Variance)

𝐸(𝑅𝐴 ) = 0.25 × 15% + 0.6 × 10% + 0.15 × 5% = 10.5%

KHANH VY 2
 𝐸(𝑅𝐵 ) = 0.25 × 10% + 0.6 × 9% + 0.15 × 10% = 9.4%
𝐸(𝑅𝑃 ) = 𝑤𝐴 × 𝐸(𝑅𝐴 ) + 𝑤𝐵 × 𝐸(𝑅𝐵 ) = 0.6 × 10.5% + 0.4 × 9.4% = 10.06%

Cách 2: each state

⦁ Return of portfolio in case economy boom / normal / recession:
𝐸(𝑅𝑃 𝑏𝑜𝑜𝑚) = 0.6 × 15% + 0.4 × 10% = 13%
𝐸(𝑅𝑃 𝑛𝑜𝑟𝑚𝑎𝑙) = 0.6 × 10% + 0.4 × 9% = 9.6%
𝐸(𝑅𝑃 𝑟𝑒𝑐𝑒𝑠𝑠𝑖𝑜𝑛) = 0.6 × 5% + 0.4 × 10% = 7%
=> Expected return on portfolio:
𝐸(𝑅𝑃 ) = ∑ 𝑝𝑖 × 𝐸(𝑅𝑃𝑖 ) = 0.25 × 13% + 0.6 × 9.6% + 0.15 × 7% = 10.06%
⦁ Variance and Standard of portfolio:
𝑉𝑎𝑟(𝑅𝑃 ) = 0.25 × (13% − 10.06%)2 + 0.6 × (9.6% − 10.06%)2
+ 0.15 × (7% − 10.06%)2 =
𝑆𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝐷𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 = √𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒 = 1.92

6. Risk and Diversification:

- Diversification: Reduced risk by spreading the portfolio across many investments.
- Market risk vs Specific risk:
+ Market risk (Systematic or Non-diversifiable risk): affect the overall stock market
(changes in GDP, inflation, interest rates,..) and measured by 𝜷: the sensitivity of a
stock’s returns to the returns on the market portfolio
⦁ 𝜷 = 𝟏: stock has the same market risk as the overall market
⦁ 𝜷 > 𝟏: stock has more market risk than the market
⦁ 𝜷 < 𝟏: stock has less market risk than the market
⦁ 𝜷 = 𝟎: risk-free asset
𝜷 𝑷 = ∑ 𝒘𝒋 × 𝜷 𝒋
𝒋=𝟏
+ Specific risk (Unsystematic or Diversifiable risk): affect only that firm (CEO
retirement, lawsuit,…) and can be eliminated by diversification.

7. Capital Asset Pricing Model (CAPM):

𝑬(𝑹) = 𝑹𝒇 + 𝜷 × (𝑹𝒎 − 𝑹𝒇 )
where 𝑅𝑓 : risk free rate
𝑅𝑚 : market return
𝑅𝑚 − 𝑅𝑓 : market risk premium (the reward for bearing systematic risk)

Note:
- Đề ghi “expected return on the market portfolio” → 𝑅𝑚 = 𝐸(𝑅𝑃 )
- Có thể dùng công thức này tính 𝐸(𝑅𝑃 )

KHANH VY 3
 𝑬(𝑹𝑷 ) = 𝑹𝒇 + 𝜷𝑷 × (𝑹𝒎 − 𝑹𝒇 )

8. Coefficient of Variance: measure the risk per unit of return. Measure risk when
expected return on 2 assets are not the same
𝝈
𝑪𝑽 =
𝒓

KHANH VY 4