1. Copyright Leslie Lum Module 3 Risk and Return

2. Copyright Leslie Lum Learning Objectives Calculate total and annualized capital gain and loss Calculate yield Calculate average annual gain Calculate rate of return Calculate real return Explain why standard deviation measures risk Calculate standard deviation Explain how beta measures risk Explain the risk characteristics of the major asset classes Explain investment risk Explain the relationship between risk and return Evaluate return per risk using the Sharpe ratio Calculate and evaluate risk and return for specific investments

3. Copyright Leslie Lum True or False? Most investors know exactly how much they make The investment with the most return is the one to go after You can’t predict when investments will tank

4. Copyright Leslie Lum Capital Gain Why do we invest? To make money on our money.

5. Copyright Leslie Lum Capital Gain

6. Copyright Leslie Lum Try some You bought AT&T at $32.77 per share and sell at $59.32 per share. What is your total holding gain? You buy Microsoft at $42.41 per share and sell at $52.94 per share. What is your total holding gain?

7. Copyright Leslie Lum Try one on the web Smart Money Website Buy GE at the end of the month January 2000 and sell GE at the end of the month January 2003.

8. Copyright Leslie Lum What if you held one investment for three years and another for one year?

9. Copyright Leslie Lum Try some You buy Microsoft for $54.97 on the last day of July 1998 and sell on the last day of July 2000 for $69.81. Calculate your annualized gain. You buy Intel for $23.01 on the last day of September 1997 and sell on the last day of July 2000 for $66.73. Calculate your annualized gain.

10. Copyright Leslie Lum It’s not always a gain--

11. Copyright Leslie Lum The same stocks You buy AT&T for $40.65 per share at the end of November 1998 and sell in July 2000 for $30.94. Calculate your annualized gain or loss. You buy Microsoft for $116.75 per share at the end of December 1999 and sell in July 2000 for $69.81. Calculate your annualized gain or loss.

12. Copyright Leslie Lum Return - Income or Yield

13. Copyright Leslie Lum Let’s look at how stocks give yield Exxon Mobil (Ticker symbol XOM) General Motors (Ticker symbol GM) Johnson and Johnson (Ticker symbol JNJ) Practice more on your own. Being able to calculate return is important. Use finance.yahoo.com

14. Copyright Leslie Lum 20/20 hindsight is great but what about the future? Stock returns will differ depending on when you bought or sold the stock. How can you know what a stock will do in the future when you buy? There’s no sure way but investors look at the average return over a period of time to predict what will happen in the future. The average takes away some of the ups and downs of stock prices.

15. Copyright Leslie Lum

16. Calculating year-to-year returns Yearly Rate of Return =

17. Copyright Leslie Lum Calculate the average annual return

18. Copyright Leslie Lum

19. Calculate average annual return

20. Copyright Leslie Lum Real Return The effect of inflation

21. Copyright Leslie Lum

22. How does inflation affect your investment?

23. Copyright Leslie Lum Which is the best return?

24. Copyright Leslie Lum After inflation, the 6% return is the best!!

25. Copyright Leslie Lum Figure out what the best real return is T-Bills in 1981 at 15% Corporate Bonds in 1988 at 14% Government Bonds in 1998 at 13%

26. Copyright Leslie Lum Risk True or false? –Risk is bad –You can go through your investment life without selecting risky investments – You can’t manage risk

27. Copyright Leslie Lum It’s July 2000 and you’re trying to decide between buying Costco or Starbucks Costco’s average monthly return for the past 5 years is 3% Starbuck’s average monthly return for the past 5 years is 3% Which do you choose?

28. Copyright Leslie Lum Given two stocks with the same return, pick the stock with less volatility

29. Copyright Leslie Lum Standard deviation is used to measure risk

30. Copyright Leslie Lum Here is the formula (Optional) Number of values Individual values

31. Copyright Leslie Lum Let’s do it for Family B— (Optional)

32. Copyright Leslie Lum Family B has more variability

33. Copyright Leslie Lum Which is the most volatile? Do calculations before looking at answers.

34. Copyright Leslie Lum Beta Beta is another measure of risk. Based on the concept that market risk or overall volatility of the market is not something an investor can control. Beta measures movement of the stock in relation to the market.

35. Copyright Leslie Lum

37. Do these betas match your hunches about the stocks?

38. Copyright Leslie Lum Estimate these betas and then go to the web for betas (finance.yahoo.com)

39. Copyright Leslie Lum Let’s put it all together Major asset classes: Risk & Return

40. Copyright Leslie Lum

45. Plot the risk return graph for these. Does the risk return relationship hold? What is the best stock for you?

46. Copyright Leslie Lum Plot the risk return graph Return (Average Return) Risk (Standard Deviation)

47. Copyright Leslie Lum Try another risk return graph

48. Copyright Leslie Lum Return per Risk Investment 1 gives a 15% return with a 25% risk. Investment 2 gives a 12% return with an 18% risk. Which one is better?

49. Copyright Leslie Lum Sharpe Ratio Creates a measure of return for every unit of risk Used to measure portfolios of investments The higher the ratio the more return you’re getting for every unit of risk

50. Copyright Leslie Lum Which is better for return per risk?

51. Copyright Leslie Lum How should you deal with volatility?