You are on page 1of 36

# | |

   

##  Basic return concepts

 Basic risk concepts
 Stand-alone risk
 Portfolio (market) risk
 Risk and return: CAPM/SML
ï at are investment returns?

## þ Investment returns measure the

financial results of an investment
þ |eturns may be historical or
prospective (anticipated).
þ |eturns can be expressed in:
Dollar terms.
Percentage terms.
ï at is t e return on an investment t at
costs \$1,000 and is sold
after 1 year for \$1,100?
þ Dollar return:
\$ |eceived - \$ Invested
\$1,100 - \$1,000 
þ Percentage return:
\$ |eturn/\$ Invested
\$100/\$1,000  
Rumus Return (Umum)
 Return terdiri atas pendapatan dari asset
(current yield) dan kenaikan arga asset
(capital gain)

k = Ct/Pt-1 + Pt-Pt-1/Pt-1
ï at is investment risk?

## þ ypically, investment returns are not

known with certainty.
þ Investment risk pertains to the
probability of earning a return less than
that expected.
þ he greater the chance of a return far
below the expected return, the greater
the risk.
Probability distribution





|ate of
    return (%)
Which stock is riskier? Why?
Assume t e Following
Investment Alternatives
Economy Prob. T-Bill HT Coll USR MP

## Boom 0.10 8.0 50.0 -20.0 30.0 43.0

1.00
t e T-bill return?

## he -bill will return 8% regardless of

the state of the economy.
Is the -bill riskless? Explain.
o t e returns of HT and Collections
move wit or counter to t e economy?

##  HT moves wit t e economy, so it is

positively correlated wit t e economy.
T is is t e typical situation.
 Collections moves counter to t e
economy. Suc negative correlation is
unusual.
Calculate t e expected rate of return
on eac alternative.
^expected rate of return.


h  ü 



## kH 0.10(-22%) + 0.20(-2%)

+ 0.40(20%) + 0.20(35%)
+ 0.10(50%) 17.4%.

k
HT 17.4%
Market 15.0
USR 13.8
T-bill 8.0
Collections 1.7

## H has the highest rate of return.

Does that make it best?
ï at is t e standard deviation
of returns for eac alternative?
  
  

  
  

ü *   


ü*

ï    


H
ï ((-22 - 17.4)20.10 + (-2 - 17.4)20.20
+ (20 - 17.4)20.40 + (35 - 17.4)20.20
+ (50 - 17.4)20.10)1/2 20.0%.
ï    ï  
ï  ï|    
ï  
 Standard deviation measures t e stand-alone
risk of an investment.
 T e larger t e standard deviation, t e ig er t e
probability t at returns will be far below t e
expected return.
 Coefficient of variation is an alternative
measure of stand-alone risk.
Expected Return versus Risk
Expected
Security return Risk, ï
HT 17.4% 20.0%
Market 15.0 15.3
USR 13.8 18.8
T-bills 8.0 0.0
Collections 1.7 13.4

## Which alternative is best?

Portfolio Risk and Return

r !"#
\$ "  
%  % 
 


 # ï#

Portfolio Return, kp

# " &  
&

 
# Õ "  



#  '() '(*

  
# " 
Alternative Met od
 !|

Economy Prob. HT Coll. Port.
Recession 0.10 -22.0% 28.0% 3.0%
Below avg. 0.20 -2.0 14.7 6.4
Average 0.40 20.0 0.0 10.0
Above avg. 0.20 35.0 -10.0 12.5
Boom 0.10 50.0 -20.0 15.0

#  ()
() (
) () (*


(
ù ïp = ((3.0 - 9.6)20.10 + (6.4 - 9.6)20.20 +
(10.0 - 9.6)20.40 + (12.5 - 9.6)20.20 +
(15.0 - 9.6)20.10)1/2 = 3.3%.
ù ïp is muc lower t an:
± eit er stock (20% and 13.4%).
± average of HT and Coll (16.7%).
 T e portfolio provides average return but
muc lower risk. T e key ere is negative
correlation.
Two-Stock Portfolios
 Two stocks can be combined to form a
riskless portfolio if r = -1.0.
 Risk is not reduced at all if t e two stocks
ave r = +1.0.
 In general, stocks ave r ' 0.65, so risk is
lowered but not eliminated.
 Investors typically old many stocks.
 ï at appens w en r = 0?
How are betas calculated?

##  Run a regression wit returns on t e stock

in question plotted on t e Y axis and
returns on t e market portfolio plotted on
t e X axis.
 T e slope of t e regression line, w ic
measures relative volatility, is defined as
t e stock¶s beta coefficient, or b.
Use t e istorical stock returns to
calculate t e beta for KïE.
Year Market KïE
1 25.7% 40.0%
2 8.0% -15.0%
3 -11.0% -15.0%
4 15.0% 35.0%
5 32.5% 10.0%
6 13.7% 30.0%
7 40.0% 42.0%
8 10.0% -10.0%
9 -10.8% -25.0%
10 -13.1% 25.0%
Calculating Beta for KïE

+



 
+    +


     
  
   
How is beta calculated?
 T e regression line, and ence beta, can
be found using a calculator wit a
regression function or a spreads eet
program. In t is example, b = 0.83.
 Analysts typically use four or five years¶
of mont ly returns to establis t e
regression line. Some use 52 weeks of
weekly returns.
How is beta interpreted?
 If b = 1.0, stock as average risk.
 If b > 1.0, stock is riskier t an average.
 If b < 1.0, stock is less risky t an average.
 Most stocks ave betas in t e range of 0.5 to
1.5.
 Can a stock ave a negative beta?
Expected Return versus Market
Risk
Expected
Security return Risk, b
HT 17.4% 1.29
Market 15.0 1.00
USR 13.8 0.68
T-bills 8.0 0.00
Collections 1.7 -0.86
þ ï  \$ 
  ,
Use t e SML to calculate eac
alternative¶s required return.

##  T e Security Market Line (SML) is part

of t e Capital Asset Pricing Model
(CAPM).
 SML: ki = kRF + (RPM)bi .
 Assume kRF = 8%; kM= kM = 15%.
 RPM = (kM - kRF) = 15% - 8% = 7%.
Required Rates of Return

##   ) '( *(

 )* '
  ) '( ( 

|  ) '( 
( 
 
    ) '( (  
  ) '( 
( 
Expected versus Required
Returns
k k
HT 17.4% 17.0% Undervalued
Market 15.0 15.0 Fairly valued
USR 13.8 12.8 Undervalued
T-bills 8.0 8.0 Fairly valued
Coll 1.7 2.0 Overvalued
 (   |-) |(
   ) '(

  

   
|-     |


 | %
   

. !r
 
Calculate beta for a portfolio wit
50% HT and 50% Collections

## # ï &  

&
  () (
 *() 
(

ï at is t e required rate of return
on t e HT/Collections portfolio?

## # ï &  

&
 '() (*


 

# |- ) |(#
 )' (*
.!#\$.\$  &
|/
|
\$|
 (
j .
0"


 

 
&    

##     

.!#\$| r 
  &
r\$
 

|/
| 
 
 
\$|
 (

  
 
 
 j | 


&    
| %

ï   r,

þ r /
!!
 # \$  
  #
"
 
/

\$


\$
  "
 
 \$ #
\$ 
þ .  #
!  1
\$
\$\$

þ ï   \$
,
ï 
  !# 
\$ r,

##  Investors all t ink in terms of

a single olding period.
 All investors ave identical expectations.
 Investors can borrow or lend unlimited
amounts at t e risk-free rate.


(