1、,Principles of Corporate Finance,Chapter 7,McGraw Hill/Irwin,Copyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved,Introduction to Risk, Return, and the Opportunity Cost of Capital,Topics Covered,75 Years of Capital Market History Measuring Risk Portfolio Risk Beta and Unique Risk Di
2、versification,The Value of an Investment of $1 in 1926,Source: Ibbotson Associates,Index,Year End,1,6402 258764.1 48.9 16.6,Source: Ibbotson Associates,Index,Year End,1,660 2676.6 5.0 1.7,Real returns,The Value of an Investment of $1 in 1926,Rates of Return 1926-2000,Source: Ibbotson Associates,Year
3、,Percentage Return,Measuring Risk,Variance - Average value of squared deviations from mean. A measure of volatility.Standard Deviation - Average value of squared deviations from mean (square root). A measure of volatility.,Measuring Risk,Coin Toss Game-calculating variance and standard deviation The
4、 expected return is (40+10+10-20)/4=10,Measuring Risk,Return %,# of Years,Histogram of Annual Stock Market Returns,Measuring Risk,Diversification - Strategy designed to reduce risk by spreading the portfolio across many investments. Unique Risk - Risk factors affecting only that firm. Also called “d
5、iversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”,Measuring Risk,Measuring Risk,Measuring Risk,Portfolio Risk,The variance of a two stock portfolio is the sum of these four boxes,Portfolio Risk,Example Suppose you inve
6、st 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10% x 65% = 6.5% and on Reebok it is 20% x 35% = 7.0%. The expected return on your portfolio is 6.5 + 7.0 = 13.50%. Assume a correlation coefficient of 1. the standard deviation of cola and Reebok are 3
7、1.5 and 58.5 respectively.,Portfolio Risk,Example Suppose you invest 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10% x 65% = 6.5% and on Reebok it is 20% x 35% = 7.0%. The expected return on your portfolio is 6.5 + 7.0 = 13.50%. Assume a correlation
8、 coefficient of 1. the standard deviation of cola and Reebok are 31.5 and 58.5 respectively.,Portfolio Risk,Example Suppose you invest 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10% x 65% = 6.5% and on Reebok it is 20% x 35% = 7.0%. The expected re
9、turn on your portfolio is 6.5 + 7.0 = 13.50%. Assume a correlation coefficient of 1.,Portfolio Risk,Portfolio Risk,The shaded boxes contain variance terms; the remainder contain covariance terms.,STOCK,STOCK,To calculate portfolio variance add up the boxes,Beta and Unique Risk,1. Total risk = divers
10、ifiable risk + market risk 2. Market risk is measured by beta, the sensitivity to market changes,Beta and Unique Risk,Market Portfolio - Portfolio of all assets in the economy. In practice a broad stock market index, such as the S&P Composite, is used to represent the market.Beta - Sensitivity of a stocks return to the return on the market portfolio.,Beta and Unique Risk,Beta and Unique Risk,Covariance with the market,Variance of the market,
