Risiko dan Return

Central Theme
• Positive relationship between risk and return
• Why ?
• Is that because investors generally risk averse (risk neutral) or risk
seekers?
The risk takers…
Are we going to observe positive relationship between risk and return
for these people?
Meet
A Real
Spiderman:
Alain Robert
of French,
Climbing
Four Seasons
Hotel Hong
Kong,
2008
Fear Factor is an American stunt/dare game show that originally aired between 2001
and 2006.. The show pits contestants against each other in a variety of stunts for a
grand prize, usually of US $50,000. Why they are willing to do these things?
Risk and Return
• Return: rate of return
• Suppose I buy stock A for Rp10.000 last year. This year, stock price
increases toRp12.000. This stock also pays dividend Rp1.000 this year.
• Calculate return for this stock?
• Return = { ((Sell price – buy price) + dividend)/buy price } x 100%
• Return = { ((12.000 – 10.000) + 1.000)/10.000 } x 100% = 30%
Risk
• One of the definitions
• Probability that actual results deviate from expectation.
• Investment in stock and bond, which one has higher probability to
deviate from expectation? Why?
• Suppose I buy stock A this year for Rp10.000. I plan to hold this stock
for one year. What is return for this stock next year, when I sell this
stock?
• What is the problem here?
 C

-100% Expected Return +1000%

I buy stock A for Rp10.000. I plan to hold thos stock for one year.
What is return next year? Risk? The problem: we don’t know selling
price next year. But humans want to know everything, including the
future.

Next year Probability Stock price, return

Economy is vey good 0.3 Rp15,000; 50%
Ekonomi is ok 0.4 Rp12,000; 20%
Ekonomi is bad 0.3 Rp8,000; -20%

Expected Return 17%

Standard Deviation 24.7%
• Expected return = 0.3 (50) + 0.4 (20) + 0.3 (-20) = 17%
• Do we get 17% for sure?? No.. Not guaranteed, there is uncertainty 
we have risk
• How to calculate risk? Standard deviation.… try to measure deviation
from expected value
• Variance =
• 0.3 (50 – 17)^2 + 0.4 (20 – 17)^2 + 0.3 (-20 – 17)^2 =
• Standard deviation = square root of variance
• s = 24,7%
Which one we choose? A, B, C? Will C never
make the list
Stock Expected Return Risk (standard
deviation)
A 10% 15%
B 15% 20%
C 8% 30%

A >C A =B
Will C be always eliminated?
Suppose we create a portofolio 50% A, 50% B,
What is the risk andreturn of the portofolio?
Economy Probability Exp Ret A Exp Ret B

Very good 0,3 50% -20%

+15%
Ok 0,4 20% +10%
+15%
Bad 0,3 -20% +30%
5%
What is interesting on this table?

Kondisi Exp Return Risiko

(deviasi standar)
Saham A 17% 49,67%

Saham B 7% 35,59%

Portofolio 12% 8,1%

50%A, 50%B
• Expected return portfolio = 0.5 (17) + 0.5 (7) = 12%
• Portfolio Risk  not the weighted average of individual risk
• Variance of portfolio =
• W1^2 std dev1^2 + w2^2 std dev2 ^2 + 2. w1. w2. correation (1 and
2). Stddev1. stddev2
• (0.5^2 x 49.67^2 ) + (0.5^2 x 35,59^2) + 2. (0.5) (0.5) (korelasi 1and2)
(49.67) (35.59)
• Correlation between two assets is very important in determining the
value of portfolio risk ...
Portfolio
• Portfolio = combination of two or more assets
• Diversification would be able to improve risk return profile: for same
risk, return increases, or for same return, risk decreases
• How can we check diversification benefit?
• Portfolio return is weighted average of individual return (12%)
• But portfolio risk (8,1%) < weighted average of individual risk
(0.5 x 50 ) + (0.5 x 35) = 42.5%
• We say, there is a diversification benefit
DIVERSIFICATION EFFECT (two
assets)
If correlation between two assets equal to +1,
then there is no diversification effect
If correlation between two assets is not equal to
+1, then there is diversification effect
The further the correlation away from +1, the
larger the diversification effect
If the correlation between two assets is -1, the
we will have the maximum diversification effect
We can create a portofolio with the risk of 0
(riskless portfolio)
 Exhibit 15.1 Portfolio Risk Reduction Through
Diversification
Percent risk = Variance of portfolio return
Variance of market return
100

80
Non-systematic risk
Total Risk = Diversifiable Risk + Market Risk
(unsystematic) (systematic)
60

40 Portfolio of
U.S. stocks
27%
20 Total
risk Systematic Sistematic risk
risk

1 10 20 30 40 50
Number of stocks in portfolio
By diversifying the portfolio, the variance of the portfolio’s return relative to the variance of the market’s
return (beta) is reduced to the level of systematic risk -- the risk of the market itself. 1-18
 Ilustration of systematic vs non-systematic
risk
• Non-systematic risk
• I invest in Astra share (Indonsia automotive company), then bad news,
Astra factory cathes fire, share price declines, we lose..
• Can this loss be eliminated? Probably
• Probably, If I invest di indomobil share (Astra competitor)..
• Systematic risk
• I invest in Astra and Indomobil shares
• Recession hits Indonesia, prices for Astra and Indomobil decline.
• We can not escape from risk of recession in Indonesia
• This is a systematic risk
• Indonesia recession is a systematic risk
• Can we change it to becpme non-systematic risk?
• How?
• We create international portfolio, such as invest in US (for
example)
• What happen if we have world recession? Such as from
covid-19
• Invest in Mars (once we have Mars colony)
Which one deserves price (value)? Sistematic
or Non-systematic risk?
• Basic Principle: something that is hard deserves higher value
• Non-systematic Risk  easy to eliminate ..
• Systematic Risk  difficult to eliminate  deserves higher value
(there should be a price for this risk)
• Becomes the background for CAPM (Capital Asset Pricing Model)
• CAPM  there is a positive relationship between risk and return, but
more specifically, systematic risk
Capital Asset Pricing Model
• One of the model (most popular one) to explain relationship between
risk and return (positive relationship)
• More specifically : systematic risk has positive relationship with return
• Equation:
• E(Ri) = RF + bi (E(RM – RF)  SML (Security Market Line) line

• CAPM explains positive relationship between risk and return

• CAPM applications: calculate risk premium, and cost of equity
CAPM
• RF = risk free rate
• RF = government bond = 6%
• Bi = taken from Bloomberg (for example) = for aset i = 1,1
• RM-RF (market risk premium)
• RM= return for market = return for stock index such as JKSE (Jakarta
Composite Stock Index)
• RM-RF is one term.. Usually around 8-9%
• From year 1990 – 2020.. Calcukate RM, RF, calculate RM-RF every year, take
average, probably around 8%
• E(Ri) = 6 + 1,1 (8) =
CAPM
• CAPM is also an equilibrium model
• Very popular among academics and practicioners
• Not the only one, many other models, such as APT (Arbitrage Pricing
Theory), three factor Fama-French model, survey, and others
• Early empirical evidence supported CAPM
• However, more recent evidence tends to invalidate CAPM
Equilibrium model. How does it work?
• According to CAPM, assets will be in equilibrium condition if assets
stay in SML line. What will happen to A, B, and C?
Expected Return

SML : Security Market Line

A
B

Beta
Other equilibrium models
• There are many other competing models
• APT (Arbitrage Pricing Model)
• Fama French 3-factor model
• Fama-French 5-factor model
• Other empirical models
• Others..