RETURN DAN RISIKO

Puput Tri Komalasari

Defining Return
Income received on an investment plus any change in market price, usually expressed as a percent of the beginning market price of the investment.

Sources of Investment Returns

Investments provide two basic types of return: Income returns(yield)

The owner of an investment has the right to any cash flows paid by the investment. The owner of an investment receives the benefit of increases in value and bears the risk for any decreases in value.

Changes in price or value (capital gain/loss)

Total Return =Yield +Price Change

Income Returns

Cash payments, usually received regularly over the life of the investment. Examples: Coupon interest payments from bonds, Common and preferred stock dividend payments.

Returns From Changes in Value

Investors also experience capital gains or losses as the value of their investment changes over time. For example, a stock may pay a $1 dividend while its value falls from $30 to $25 over the same time period.

Measuring Returns

Dollar Returns

How much money was made on an investment over some period of time? Total Dollar Return = Income + Price Change
By dividing the Total Dollar Return by the Purchase Price (or Beginning Price), we can better gauge a return by incorporating the size of the investment made in order to get the dollar return.

Holding Period Return

Risk and Risk Premiums

Rates of Return: Single Period
Return = Capital gain (loss) + yield

P1 P0 D1 HPR P0 HPR = Holding Period Return

P0 = Beginning price
P1 = Ending price

D1 = Dividend during period one

Return Example
The stock price for Stock A was $10 per share 1 year ago. The stock is currently trading at $9.50 per share, and shareholders just received a $1 dividend. What return was earned over the past year?

$1.00 + ($9.50 - $10.00 ) = 5% R= $10.00

For a Treasury security, what is the required rate of return? Required rate of = return

For a Treasury security, what is the required rate of return? Required Risk-free rate of = rate of return return
Since Treasurys are essentially free of default risk, the rate of return on a Treasury security is considered the risk-free rate of return.

For a corporate stock or bond, what is the required rate of return? Required rate of = return

For a corporate stock or bond, what is the required rate of return? Required Risk-free rate of = rate of return return

For a corporate stock or bond, what is the required rate of return? Required Risk-free rate of = rate of return return

Risk + Premium

How large of a risk premium should we require to buy a corporate security?

Returns
Expected

Return - the return that an investor expects to earn on an asset, given its price, growth potential, etc.
Return - the return that actually received or earned by investor.

Realized

Determining Realized Return

Total Return Relative Return Adjusted Return

Determining Average Return

Arithmetic Return Geometric Return

RELATIVE RETURN
Relative Return = Total Return + 1

Relative Return =

Dt + (Pt - Pt-1 )

+1

Pt-1
Relative Return =

Dt + Pt

Pt-1

ADJUSTED RETURN
Return adjusted by inflation

RIA =

(1 + R ) (1 + IF)

-1

INFLATION-INTEREST RATE RELATIONSHIP

Factors Influencing Rates:

1. Supply o Households 2. Demand oBusinesses 3. Governments Net Supply and/or Demand oFederal Reserve Actions

Real and Nominal Rates of Interest

Nominal interest rate
Growth rate of your money

Real interest rate

Growth rate of your purchasing power

If R is the nominal rate and r the real rate and i is

the inflation rate (fisher effect):

r= Ri 6% i Example: r 3%, =
R = 9% = 3% + 6% or r = 9% - 6% = 3% r = (R - i) / (1 + i) = (9%-6%) / (1.06) = 2.83%

Fisher effect: Exact

Equilibrium Real Rate of Interest

Determined by:
Supply Demand Government actions

Expected rate of inflation

Figure 5.1 Determination of the Equilibrium Real Rate of Interest

Equilibrium Nominal Rate of Interest

As the inflation rate increases, investors will

demand higher nominal rates of return

If E(i) denotes current expectations of inflation,

then we get the Fisher Equation:

R r E (i )

Taxes and the Real Rate of Interest

Tax liabilities are based on nominal income
Given a tax rate (t), nominal interest rate (R),

after-tax interest rate is R(1-t)

Real after-tax rate is:

R(1 t ) i (r i)(1 t ) i r (1 t ) it

Annualized Returns
If we have return or income/price change information over a time period in excess of one year, we usually want to annualize the rate of return in order to facilitate comparisons with other investment returns. We typically express all investment as an effective annual rate (EAR)

Examples:
Suppose prices of zero coupon bond

treasuries with $100 face value and various maturities are as follows:
Horizon, T Price
Half-year 1 year 25 years $97.36 $95.52 $23.30

Total Return
(100/97.36) 1 (100/95.52) 1 (100/23.30) 1 0.0271 0.0469 3.2918

Risk-Free Return for Given Horizon 2.71% 4.69% 329.18%

EAR
5.49% ? 6.0%

1 EAR 1 rf (T )

1/ T

ANNUAL PERCENTAGE RATES

Rates on short-term investments (T<1 year) often are annualized using simple rather than compound interest. APR = n x rf(T)

Measuring Historic Returns

Starting with annualized Holding Period Returns, we often want to calculate some measure of the average return over time on

an investment. Two commonly used measures of average:

Arithmetic Mean Geometric Mean

Arithmetic Mean Return

The arithmetic mean is the simple average of a series of returns. Calculated by summing all of the returns in the series and dividing by the number of values. RA = (SHPR)/n Oddly enough, earning the arithmetic mean return for n years is not generally equivalent to the actual amount of money earned by the investment over all n time periods.

Arithmetic Mean Example

Year Holding Period Return 1 10% 2 30% 3 -20% 4 0% 5 20%
RA = (SHPR)/n = 40/5 = 8%

Geometric Mean Return

The geometric mean is the one return that, if earned in each of the n years of an investments life, gives the same total dollar result as the actual investment.
It is calculated as the nth root of the product of all of the n return relatives of the investment.

RG = [P(Return Relatives)]1/n 1

Geometric Mean Example

Year Holding Period Return 1 10% 2 30% 3 -20% 4 0% 5 20% Return Relative 1.10 1.30 0.80 1.00 1.20

RG = [(1.10)(1.30)(.80)(1.00)(1.20)]1/5 1 RG = .0654 or 6.54%

Arithmetic vs. Geometric

To ponder which is the superior measure, consider the same example with a $1000 initial investment. How much would be accumulated? Year Holding Period Return Investment Value 1 10% $1,100 2 30% $1,430 3 -20% $1,144 4 0% $1,144 5 20% $1,373

Arithmetic vs. Geometric

How much would be accumulated if you earned the arithmetic mean over the same time period? Value = $1,000 (1.08)5 = $1,469 How much would be accumulated if you earned the geometric mean over the same time period? Value = $1,000 (1.0654)5 = $1,373 Notice that only the geometric mean gives the same return as the underlying series of returns.

Determining Expected Return (Discrete Dist.)

R = S ( Ri )( Pi )
i=1 n

R is the expected return for the asset, Ri is the return for the ith possibility, Pi is the probability of that return occurring, n is the total number of possibilities.

Expected Return
State of Probability Return Economy (P) Comp. A Comp. B Recession .20 4% -10% Normal .50 10% 14% Boom .30 14% 30% For each firm, the expected return on the stock is just a weighted average:

Expected Return
State of Probability Return Economy (P) Comp. A Comp. B Recession .20 4% -10% Normal .50 10% 14% Boom .30 14% 30% For each firm, the expected return on the stock is just a weighted average:
R = P1*R1 + P2*R2 + ...+ Pn*Rn

Expected Return
State of Probability Economy (P) Recession .20 Normal .50 Boom .30 Return
Comp. A Comp. B

4% 10% 14%

-10% 14% 30%

R = P1*R1 + P2*R2 + ...+ Pn*Rn RA = .2 (4%) + .5 (10%) + .3 (14%) = 10%

Expected Return
State of Probability Economy (P) Recession .20 Normal .50 Boom .30 Return
Comp. A Comp. B

4% 10% 14%

-10% 14% 30%

R = P1*R1 + P2*R2 + ...+ Pn*Rn RB = .2 (-10%)+ .5 (14%) + .3 (30%) = 14%

Based only on your expected return calculations, which stock would you prefer?

Have you considered

RISK?

Defining Risk
The variability of returns from those that are expected.
What rate of return do you expect on your investment (savings) this year? What rate will you actually earn? Does it matter if it is a bank CD or a share of stock?

Defining Risk
The possibility that an actual return will differ from our expected return. Uncertainty in the distribution of possible outcomes.

What is Risk?
Uncertainty in the distribution of possible outcomes.

Company A
0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 4 8 12

return

What is Risk?
Uncertainty in the distribution of possible outcomes.

Company A
0.5 0.45 0.4 0.35 0.3 0.25 0.2 0.15 0.1 0.05 0 4 8 12
0.2 0.18 0.16 0.14 0.12 0.1 0.08 0.06 0.04 0.02 0 -10 -5

Company B

10

15

20

25

30

return

return

What is risk?

Risk is the uncertainty associated with the return on an investment. Risk can impact all components of return through:

Fluctuations in income returns; Fluctuations in price changes of the investment; Fluctuations in reinvestment rates of return.

Risk Sources
Interest Rate Risk
Affects income return

Financial Risk
Tied to debt financing

Market Risk
Overall market effects

Liquidity Risk
Marketability with-out sale prices

Inflation Risk
Purchasing power variability

Exchange Rate Risk Country Risk

Political stability

Business Risk

6-46

Risk Types
Two general types:
Systematic (general) risk
Pervasive, affecting all securities, cannot be avoided Interest rate or market or inflation risks

Nonsystematic (specific) risk

Unique characteristics specific to issuer

Total Risk = General Risk + Specific Risk

6-47

How do we Measure Risk?

To get a general idea of a stocks price variability, we could look at the stocks price range over the past year.

How do we Measure Risk?

A more scientific approach is to examine the stocks STANDARD DEVIATION of returns. Standard deviation is a measure of the dispersion of possible outcomes. The greater the standard deviation, the greater the uncertainty, and therefore , the greater the RISK.

Standard Deviation

(Ri -

2 R)

Pi

i=1

Which stock would you prefer? How would you decide?

Which stock would you prefer? How would you decide?

Summary
Company A Company B

Expected Return
Standard Deviation

10%
3.46%

14%
13.86%

It depends on your tolerance for risk!

It depends on your tolerance for risk!

Return

Risk

Remember theres a tradeoff between risk and return.

Determining Expected Return (Continuous Dist.)

R = S ( Ri ) / ( n )
i=1 n

R is the expected return for the asset, Ri is the return for the ith observation, n is the total number of observations.

Determining Standard Deviation (Risk Measure)

s = S ( Ri - R )2
i=1 n

(n)
Note, this is for a continuous distribution where the distribution is for a population. R represents the population mean in this example.

Coefficient of Variation
The coefficient of variation is the ratio of the standard deviation divided by the return on the investment; it is a measure of risk per unit of return. CV = s/RA The higher the coefficient of variation, the riskier the investment.