Please enable JavaScript.

Coggle requires JavaScript to display documents.

Risk and return, Slide no 21- risk and return - Coggle Diagram

- - - - a collection of investments all owned by the same individual or organization
        
        Stock: investments in individual businesses
        
        Bonds: investments in debt that are designed to earn interest
        
        Mutual funds: pools of money from many investors that are invested by professionals or according to indices
      - Portfolio theory is the quantitative analysis of the trade-off between benefits and costs to find an optimal risk management
    - - Uncertainty with regard to the portfolio’s return.
      - Expected portfolio return
      - Standard deviation of a portfolio return
    - - Risk averse investors assign a welfare or utility to each available investment portfolios
      - The utility (U) used by the CFA Institute and many finance theorists and practitioners
      - func
        
        slide no69 - risk and return
        
        𝐴 in function is the risk aversion of the investor
        
        Depends on the risk preferences of the investor
        
        In practice, a risk tolerance questionnaire is used to estimate A
        
        assessment
        
        ○ If A > 0: risk-averse
        
        The higher A --> the higher required return to take the risk
        
        ○ If A = 0:risk-neutral
        
        Investors only cares for the expected return and not the risk
        
        ○ If A < 0: risk-lover
        
        higher U
        
        preferable
        
        higher risk
  - - - firm specific
        
        Risk due to factors within the firm (Business risk vs. Financial risk)
        
        Diversification can effectively eliminate firm specific (unsystematic) risk
        
        Example: Stock price will most likely fall if major government contract is lost unexpectedly
      - market
        
        Diversification does not reduce
        market related (systemic) risk
        
        Example: Stock price is likely to rise
        if overall stock market doing well
        
        Risk due to overall market
        conditions
    - - slide no53,54 - risk and return
    - - In practice, systematic risk is estimated as the slope of a straight line
        
        𝑅i = 𝛼 + 𝛽𝑅m+ 𝜀
      - Beta func
        
        Single beta: Slide no56 - risk and return
        
        Portfolio beta: taking a simple weighted average of the betas for the individual investments contained in the portfolio
      - Systematic risk is measured by beta coefficient, which estimates the extent to which a particular investmentʼs returns vary with the returns on the market portfolio
- - - - standard deviation is the measure of
        
        uncertainty
        
        investment risk
        
        dispersion of returns
        
        Measures how concentrated the data are around the mean; the more concentrated, the smaller the standard deviation.
      - std dev calculation
        
        period return analysis
        
        func
        
        std dev
        
        variance
        
        scenario analysis
        
        func
        
        Slide no 25 - risk and return
      - Variance (σ2) is a measure of the dispersion of a set of data points around their mean value (µ)
    - - types
        
        Input/output channels
        
        Loss of production facilities
        
        Liability risk
        
        Price risks
        
        Competitor risk
      - calculation
        
        multiplying the probability of an incident
        occurring by its potential losses
      - def
        
        Example: if you are a temporary office worker, your exposure to the risk of a layoff is relatively high
        
        If you face a particular type of risk because of your job, the nature of your business, or your pattern of consumption… you are said to have a particular risk exposure
        
        Risk exposure is a quantified loss potential of business
    - - uncertainty
        
        exists when everyone does not know for sure what will occur in the future (potential for unexpected events to occur)
        
        An unrealized event is uncertain for an observer at a given time if
        he/she does not know its outcome at that time
      - risk
        
        uncertainty that “matters” because it affects people’s welfare
        
        Many resource allocation decisions, such as saving, investment, financing decisions… are significantly influenced by the presence of risk
  - - - why calculate?
        
        investors want to know the annual (or other period) rate of return over a number of years (periods)
      - methods
        
        arithmetic average (simple average)
        
        char
        
        computation of the arithmetic average does not consider the effects of interest/return compounding
        
        func
        
        slide n10 - risk and return
        
        geometric average (time-weighted return)
        
        char
        
        considers compounding
    - - types
        
        realized return
        
        use HPR
        
        def
        
        The rate of return that is earned on an investment over a particular period of time
        
        func
        
        for stock
        
        Slide no7 - risk and return
        
        general
        
        Slide no6 - risk and return
        
        period return analysis
        
        historical return
        
        expected return
        
        characteristics
        
        Future returns are not known with certainty
        
        def
        
        The return that an asset is expected to generate in future
        
        Expected return is the mean (µ) of the probability distribution of possible returns
        
        scenario analysis
        
        func
        
        Slide no13 - risk and return
      - definition
        
        total gain or loss experienced on an investment over a given period expressed as a percentage of the investment’s value
        
        rt = actual, expected, or required rate of return during period t
        
        Ct = cash (flow) received from the asset investment in the time period t-1 to t
        
        Pt = price (value) of asset at time t
        
        P(t-1) = price (value) of asset at time t - 1