Download presentation

Presentation is loading. Please wait.

1
**Principles of Corporate Finance**

Seventh Edition Richard A. Brealey Stewart C. Myers Chapter 7 Introduction to Risk, Return, and the Opportunity Cost of Capital Slides by Matthew Will McGraw Hill/Irwin Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved

2
**Topics Covered 75 Years of Capital Market History Measuring Risk**

Portfolio Risk Beta and Unique Risk Diversification

3
**The Value of an Investment of $1 in 1926**

6402 2587 64.1 48.9 16.6 Index 1 Year End Source: Ibbotson Associates 13

4
**The Value of an Investment of $1 in 1926**

Real returns 660 267 6.6 5.0 1.7 Index 1 Year End Source: Ibbotson Associates 13

5
**Rates of Return 1926-2000 Percentage Return Year**

Source: Ibbotson Associates 14

6
**Average Market Risk Premia (1999-2000)**

Risk premium, % Country

7
Measuring Risk Variance - Average value of squared deviations from mean. A measure of volatility. Standard Deviation - Average value of squared deviations from mean. A measure of volatility.

8
Measuring Risk Coin Toss Game-calculating variance and standard deviation

9
**Measuring Risk Histogram of Annual Stock Market Returns # of Years**

10
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 “diversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.” 18

11
Measuring Risk 19

12
Measuring Risk 20

13
Measuring Risk 21

14
Portfolio Risk The variance of a two stock portfolio is the sum of these four boxes 19

15
**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 = 13.50%. Assume a correlation coefficient of 1. 19

16
**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 = 13.50%. Assume a correlation coefficient of 1. 19

17
**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 = 13.50%. Assume a correlation coefficient of 1. 19

18
Portfolio Risk 19

19
**Portfolio Risk To calculate portfolio variance add up the boxes**

The shaded boxes contain variance terms; the remainder contain covariance terms. 1 2 3 4 5 6 N To calculate portfolio variance add up the boxes STOCK STOCK

20
**Copyright 1996 by The McGraw-Hill Companies, Inc**

Beta and Unique Risk 1. Total risk = diversifiable risk + market risk 2. Market risk is measured by beta, the sensitivity to market changes beta Expected return market 10% - + +10% stock Copyright 1996 by The McGraw-Hill Companies, Inc -10%

21
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 stock’s return to the return on the market portfolio.

22
Beta and Unique Risk

23
Beta and Unique Risk Covariance with the market Variance of the market

Similar presentations

© 2017 SlidePlayer.com Inc.

All rights reserved.

Ads by Google