1 1 C h a p t e r A Brief History of Risk and Return second edition Fundamentals of Investments Valuation & Management Charles J. Corrado Bradford D. Jordan McGraw Hill / IrwinSlides by Yee-Tien (Ted) by the McGraw- Hill Companies Inc.All rights reserved.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Who Wants To Be A Millionaire?

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin A Brief History of Risk and Return Our goal in this chapter is to see what financial market history can tell us about risk and return. Goal  Two key observations emerge.  There is a reward for bearing risk, and at least on average, that reward has been substantialكبير.  Greater rewards are accompanied by greater risks.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Returns Example Total dollar return = Dividend + Capital gain on stock income (or loss) Total dollar return The return on an investment measured in dollars that accounts for all cash flows and capital gains or losses.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Returns Example Percent return = Dividend + Capital gains on stock yield yield or Total dollar return. Beginning stock price Total percent return The return on an investment measured as a % of the originally invested sum that accounts for all cash flows and capital gains or losses. It is the return for each dollar invested.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Returns Example: Calculating Returns  Suppose you invested $1,000 in a stock at $25 per share. After one year, the price increases to $35. For each share, you also received $2 in dividends.  Dividend yield = $2 / $25 = 8%  Capital gains yield = ($35 – $25) / $25 = 40%  Total percentage return = 8% + 40% = 48%  Total dollar return = 48% of $1,000 = $480  At the end of the year, the value of your $1,000 investment is $1,480.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Work the Web  For more information on investments, check out:   For more information on common stocks, check out:   

The Historical Record: A First Look McGraw Hill / Irwin

The Historical Record: A Longer Range Look 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

The Historical Record: A Closer Look Figure by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

The Historical Record: A Closer Look 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

The Historical Record: A Closer Look 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

The Historical Record: A Closer Look 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

The Historical Record: A Closer Look 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Work the Web  To learn more about global market history, visit: 

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Average Returns: The First Lesson  Average annual =  yearly returns return number of years

Average Returns: The First Lesson 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Average Returns: The First Lesson Risk-free rate The rate of return on a riskless investment. Risk premium The extra return on a risky asset over the risk-free rate; the reward for bearing risk.

Average Returns: The First Lesson 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Average Returns: The First Lesson The First Lesson  There is a reward, on average, for bearing risk.

Return Variability: The Second Lesson 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Return Variability: The Second Lesson Variance A common measure of volatility. Standard deviation The square root of the variance. Normal distribution A symmetricمتماثل, bell-shaped frequency distribution that is completely defined by its average and standard deviation.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Return Variability: The Second Lesson Variance of return where N is the number of returns Standard deviation of return

Return Variability: The Second Lesson

Return Variability: The Second Lesson 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Work the Web  For an easy-to-read review of basic statistics, see: 

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Return Variability: The Second Lesson The Second Lesson  The greater the potential محتملة rewards the greater the risk.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Return Variability: The Second Lesson Source: Dow Jones Top 12 One-Day Percentage Changes in the Dow Jones Industrial Average October 19, %March 14, % October 28, October 26, October 29, July 21, November 6, October 18, December 18, February 1, August 12, October 27, by the McGraw- Hill Companies Inc.All rights reserved.

Risk and Return 1 - by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Risk and Return  The risk-free rate represents compensation for just waiting. So, it is often called the time value of money.  If we are willing to bear risk, then we can expect to earn a risk premium, at least on average.  Further, the more risk we are willing to bear, the greater is that risk premium.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin A Look Ahead  We will learn how to value different assets and make informed, intelligent decisions about the associated risks.  We will also discuss different trading mechanisms and the way different markets function. This text focuses exclusively on financial assets: stocks, bonds, options, and futures.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Chapter Review  Returns  Dollar Returns  Percentage Returns  The Historical Record  A First Look  A Longer Range Look  A Closer Look

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Chapter Review  Average Returns: The First Lesson  Calculating Average Returns  Average Returns: The Historical Record  Risk Premiums  The First Lesson

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Chapter Review  Return Variability: The Second Lesson  Frequency Distributions and Variability  The Historical Variance and Standard Deviation  The Historical Record  Normal Distribution  The Second Lesson  Risk and Return  The Risk-Return Trade-Off  A Look Ahead

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin Questios & Answers( Chapter 1)  What are the two parts of total return? They are: direct cash flow “Dividend”, and Capital gain or loss.  Why are unrealised capital gains or losses included in the calculations of returns? Because capital gain or loss is every bit as much a part of the investor’s return as the dividend, and he should certainly count it as part of his return.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin  What is the difference between a dollar return and a percentage return? * Both are usefull to summarise information about return, but “percentage” is more convenient. We answer the question: “How much do we actually invest?” by dollar term, but to answer the question: “How much do we get for each dollar we invest?” We answer by percentage returns.

 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin