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Risk & Rates of Return - Part 3
Risk & Rates of Return - Part 3
Stand-alone risk
Portfolio risk
Risk & return:
Expected return
standard deviation
Coefficient of variation
5-1
Investment returns
Return =
Amount invested
– Portfolio risk –
the risk the investor would face if he held a number
of stocks in a portfolio
5-3
What is investment risk?
• Investment risk is related to the probability of earning a low
or negative actual return.
5-4
Risk-Return Tradeoff
Firm X
Firm Y
Rate of
-70 0 15 100 Return (%)
5-8
Selected Realized Returns,
1926 – 2001
Average Standard
Return Deviation
Small-company stocks 17.3% 33.2%
Large-company stocks 12.7 20.2
L-T corporate bonds 6.1 8.6
L-T government bonds 5.7 9.4
U.S. Treasury bills 3.9 3.2
5-9
Investment alternatives
5-10
Why is the T-bill return independent of the economy?
Do T-bills promise a completely risk-free return?
5-11
How do the returns of HT and Coll. behave
in relation to the market?
5-12
Return: Calculating the expected return
for each alternative
^
k expected rate of return
^ n
k
i 1
k i Pi
^
k HT (-22.%) (0.1) (-2%) (0.2)
(20%) (0.4) (35%) (0.2)
(50%) (0.1) 17.4%
5-13
Summary of expected returns for all
alternatives
Exp return
HT 17.4%
Market 15.0%
USR 13.8%
T-bill 8.0%
Coll. 1.7%
Standard deviation
Variance 2
n
(k k̂ ) P
i1
i
2
i
5-15
Standard deviation calculation
n ^
(k
i1
i k ) 2
Pi
1
(8.0 - 8.0) (0.1) (8.0 - 8.0) (0.2)
2 2
2
5-16
Comparing standard deviations
Prob.
T - bill
USR
HT
5-19
Coefficient of Variation (CV)
Std dev
CV ^
Expected return k
5-20
Risk rankings,
by coefficient of variation
CV
T-bill 0.000
HT 1.149
Coll. 7.882
USR 1.362
Market 1.020
Collections has the highest degree of risk per unit
of return.
HT, despite having the highest standard deviation
of returns, has a relatively average CV.
5-21
Illustrating the CV as a measure of relative
risk
Prob.
A B
5-23
QUESTIONS
5-24
Question
5-25