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Lecture Contemporary financial management (9th Edition): Chapter 5 - Moyer, McGuigan, Kretlow

Lecture Contemporary financial management (9th Edition) - Chapter 5: Analysis of risk and return. This chapter develops the risk-return relationship for individual projects (investments) and a portfolio of projects. | 5 Analysis of Risk and Return Introduction This chapter develops the risk-return relationship for individual projects (investments) and a portfolio of projects. Risk and Return Risk refers to the potential variability of returns from a project or portfolio of projects. Returns are generated from cash flows. Risk-free returns are known with certainty. U.S. Treasury Securities Check out interest rates on the following URLs http://www.stls.frb.org/fred/data/irates.html http://www.bloomberg.com/ Expected Return Expected return is a weighted average of the individual possible returns. The symbol for expected return, r, is called “r hat.” r = Sum (all possible returns their probability) ^ ^ Let’s Analyze Risk Standard Deviation is an absolute measure of risk. See Tables 5.2, 5.3, and 5.4 and Figure 5.1. Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Coefficient of variation v is a relative measure of risk. Risk is an increasing function of time. See Figure 5.3. Calculating the Z Score Z score measures the number of standard deviations a particular rate of return r is from the expected value of r. See Figure 5.2. Z score = Target score – Expected value Standard deviation ^ Calculating the Z Score What’s the probability of a loss (i.e., a negative return) on an investment with an expected return of 20 percent and a standard deviation of 17 percent? (0% – 20%)/17% = –1.18 rounded From table V = 0.1190 or 11.9 percent probability of a loss Coefficient of Variation The coefficient of variation is an appropriate measure of total risk when comparing two investment projects of different size. Coefficient of Variation Consider two assets, T and S. Asset T has expected annual returns of 25% and a standard deviation of 20%, whereas Asset S has expected annual returns of 10% and a standard deviation of 18%. Although Asset T has a higher standard deviation than Asset S, intuition tells us that Asset T is less risky, because its . | 5 Analysis of Risk and Return Introduction This chapter develops the risk-return relationship for individual projects (investments) and a portfolio of projects. Risk and Return Risk refers to the potential variability of returns from a project or portfolio of projects. Returns are generated from cash flows. Risk-free returns are known with certainty. U.S. Treasury Securities Check out interest rates on the following URLs http://www.stls.frb.org/fred/data/irates.html http://www.bloomberg.com/ Expected Return Expected return is a weighted average of the individual possible returns. The symbol for expected return, r, is called “r hat.” r = Sum (all possible returns their probability) ^ ^ Let’s Analyze Risk Standard Deviation is an absolute measure of risk. See Tables 5.2, 5.3, and 5.4 and Figure 5.1. Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Let’s Analyze Risk Coefficient of variation v is a relative measure of risk. Risk is an increasing function of .