Risk and

Return

By :
Mohammad rahim
 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.

Dt + (Pt - Pt-1 )
R=
Pt-1
 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?
 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 )
R= = 5%
$10.00
 Defining Risk

The variability of returns from

those that are expected.
 Total Risk

Click to edit the



Total Risk = Systematic Risk

outline text +
format
Unsystematic Risk
Second
Outline
Level
Systematic Risk is the variability of return on
− Third
stocks or portfolios associated withOutline
changes in
return on the market as Level
a whole.
Unsystematic Risk is the variability

Fourth
of return on
stocks or portfolios not explainedOutline
by general
market movements. It is avoidable Level through
diversification. − Fifth
Outline
Level
−
 Total Risk = Systematic Risk +
Unsystematic Risk

Factors such as changes in nation’s

STD DEV OF PORTFOLIO RETURN

economy, tax reform by the Congress,

or a change in the world situation.

Unsystematic risk
Total
Risk
Systematic risk

NUMBER OF SECURITIES IN THE PORTFOLIO

 Total Risk = Systematic Risk +
Unsystematic Risk

Factors unique to a particular company

STD DEV OF PORTFOLIO RETURN

or industry. For example, the death of a

key executive or loss of a governmental
defense contract.

Unsystematic risk
Total
Risk
Systematic risk

NUMBER OF SECURITIES IN THE PORTFOLIO

 Determining Expected Return
(Discrete Dist.)

n
R=Σ ( Ρ ι )( Π ι )
i=1

Ρ ι σ τ ηε ε ξ π ε χ τ ε δ
ρ ε τ υ ρ ν φ ο ρ τ ηε ασ
σε τ ,
Ρ ι ι σ τ ηε ρ ε τ υ ρ ν φ
ο ρ τ ηε ι τ η π ο σσι β
ι λ ι τ ψ,
 How to Determine the
Expected Return and
Standard Deviation
Stock BW
Ri Pi (Ri)(Pi)
The
-.15 .10 -.015
expected
-.03 .20 -.006 return, R,
.09 .40 .036 for Stock
.21 .20 .042 BW is .09
.33 .10 .033 or 9%
Sum 1.00 .090
 Determining Standard
Deviation (Risk Measure)

n
σ = Σ ( Ρ ι − Ρ )2( Π ι )
i=1

Σ τ αν δ αρ δ ∆ ε ϖι α τ ι ο ν , σ , ι
σ α σ τ ατ ι σ τ ι χ αλ µ ε ασυ ρ
ε ο φ τ ηε ϖαρ ι αβ ι λ ι τ ψ ο
φ α δ ι σ τ ρ ι β υ τ ι ο ν αρ ο υ ν
δ ι τ σ µ ε αν .
Ι τ ι σ τ ηε σθ υ αρ ε ρ ο ο τ ο
 How to Determine the
Expected Return and
Standard Deviation
Stock BW
Ri Pi (Ri)(Pi) (Ri - R )2(Pi)
-.15 .10 -.015 .
00576
-.03 .20 -.006 .
00288
.09 .40 .036 .
00000
.21 .20 .042 .
 Determining Standard
Deviation (Risk Measure)

n
σ = Σ i=1
( Ρ ι − Ρ )2( Π ι )

σ = .01728
σ = .1315 ο ρ 13.15%
 Coefficient of Variation

The ratio of the standard deviation of a distribution to

the mean of that distribution.
It is a measure of RELATIVE risk.

CV = σ / Ρ
Χς ο φ ΒΩ = .1315 / .09 = 1
.46
 Discrete vs. Continuous
Distributions

Discrete Continuous

0.4 0 .0 3 5
0.35
0 .0 3
0.3
0.25 0 .0 2 5
0.2 0 .0 2
0.15
0 .0 1 5
0.1
0.05 0 .0 1
0 0 .0 0 5
-15% -3% 9% 21% 33%
0

4%
-5%

13%

40%

67%
22%
31%

49%
58%
-50%
-41%

-23%
-14%
-32%
 Determining Expected Return
(Continuous Dist.)

n
R=Σ ( Ρ ι ) / ( ν )
i=1
Ρ ι σ τ ηε ε ξ π ε χ τ ε δ
ρ ε τ υ ρ ν φ ο ρ τ ηε ασ
σε τ ,
Ρ ι ι σ τ ηε ρ ε τ υ ρ ν φ
ο ρ τ ηε ι τ η ο β σε ρ ϖ
ατ ι ο ν ,
 Determining Standard
Deviation (Risk Measure)

n
σ = Σi=1( Ρ ι − Ρ )2
( ν )
Νο τ ε , τ ηι σ ι σ φ ο ρ
α χ ο ν τ ι ν υ ο υ σ δ ι
στ ρ ι β υ τ ι ο ν ωηε ρ
ε τ ηε δ ι στ ρ ι β υ τ
 Determining Portfolio
Expected Return

m
RP = Σ ( Ω ϕ )( Ρ ϕ )
j=1
Ρ Π ι σ τ η ε ε ξ π ε χ τ ε δ ρ ε τ
υ ρ ν φ ο ρ τ ηε π ο ρ τ φ ο λ ι ο ,
Ω ϕ ι σ τ η ε ω ε ι γ η τ (ι ν ϖε σ
τ µ ε ν τ π ρ ο π ο ρ τ ι ο ν ) φ ο ρ
τ ηε ϕ τ η ασσε τ ι ν τ ηε π ο
ρ τ φ ο λ ι ο ,
Ρ ϕ ι σ τ ηε ε ξ π ε χ τ ε δ ρ ε τ
 Determining Portfolio Standard
Deviation

m m
σΠ = Σj=1 k=1Σ Ω ϕ Ω κ σ
ϕκ
Ωϕ ι σ τ η ε ω ε ι γ η τ (ι ν ϖ ε σ
τ µ ε ν τ π ρ ο π ο ρ τ ι ο ν ) φ ο ρ
τ ηε ϕ τ η ασσε τ ι ν τ ηε π ο
ρ τ φ ο λ ι ο ,
Ω κ ι σ τ η ε ω ε ι γ η τ (ι ν ϖ ε σ
τ µ ε ν τ π ρ ο π ο ρ τ ι ο ν ) φ ο ρ
 What is Covariance?

σ ϕκ = σ ϕ σ κ ρ ϕκ
σϕ ι σ τ ηε στ αν δ αρ δ δ ε
ϖι ατ ι ο ν ο φ τ η ε ϕ τ η ασ σ
ε τ ι ν τ ηε π ο ρ τ φ ο λ ι ο ,
σκ ι σ τ ηε σ τ αν δ αρ δ δ ε ϖ
ι ατ ι ο ν ο φ τ η ε κ τ η ασσε
τ ι ν τ ηε π ο ρ τ φ ο λ ι ο ,
ρ ϕκ ι σ τ ηε χ ο ρ ρ ε λ ατ ι ο ν
 Correlation Coefficient

A standardized statistical measure of the linear

relationship between two variables.

Its range is from -1.0 (perfect negative

correlation), through 0 (no correlation), to +1.0
(perfect positive correlation).
 What is Beta?

An index of systematic risk.

It measures the sensitivity of a stock’s returns to
changes in returns on the market portfolio.
The beta for a portfolio is simply a weighted
average of the individual stock betas in the
portfolio.
measuring relative risk

if some risk is diversifiable,

then σ is not the best measure of risk
σ is an absolute measure of risk
need a measure just for the systematic component
Beta, β

variation in asset/portfolio return

relative to return of market portfolio
mkt. portfolio = mkt. index

% change in asset return

β =
% change in market return
interpreting β

if β = 0
ασσε τ ι σ ρ ι σκ φ ρ ε ε
ι φ β = 1
ασσε τ ρ ε τ υ ρ ν = µ αρ κ ε τ ρ ε
τ υ ρ ν
ι φ β > 1
ασσε τ ι σ ρ ι σκ ι ε ρ τ ηαν µ α
ρ κ ε τ ι ν δ ε ξ

β < 1
ασσε τ ι σ λ ε σσ ρ ι σκ ψ τ ηα
Thank you

By:
Mohammad