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Risk and Rate of Return

In: Business and Management

Submitted By kakhai18
Words 4013
Pages 17
Risk and Return Concepts
Prepared by: JQY

Risk and Return Concepts
• Measures of risk and returns
• Portfolio risk and returns
• CAPM
Return – what is earned on an investment: the sum of income and capital gains generated by an investment.
Risk – possibility of loss; the uncertainty that the anticipated return will not be achieved.

Risk and Return?
If you have PHP 1,000,000, will you invest in:

5%

20%

Risk and Return
General Rule of Thumb:
More Risk = More Returns
Less Risk = Less Returns
It depends on the investor:
Risk Seeking – prefers high risk investments Risk Neutral – willing to take on moderate risk
Risk Averse – conservative, unwilling to take on high risk investments unless the returns justify and compensates for the high risk taken.

Relative Risk & Returns of Asset Classes

Source: http://www.weblivepro.com/articles/cpp/cppinfo.aspx

Measures of Returns
• Historical Returns
▫ Holding Period Return
▫ Alternative Measures
 Arithmetic Mean
 Geometric Mean
 Harmonic Mean

• Expected Returns

Measuring Historical Returns
• Holding Period Return
▫ Total return on an asset or portfolio over the period during which it was held
▫ HPR =

MV1 – MV0 + D
MV0

MV1 = market value, end
MV0 = market value, beginning
D = cumulative cash distributions (at the end of period)

• Annualized HPR
▫ (1 + HPR) ^ 1/n – 1

Measuring Historical Returns
• Example:
Mr. A bought an asset in 2005 for P100. He kept it for one year and sold it for P120 in 2006. He received a P5 dividend during 2006. What is the
HPR on Mr. A’s investment?
MV1 – MV0 + D
HPR =
MV0
= 25%

=

120 – 100 + 5
100

Alternative Historical Return Measures:
Returns for five years are 7%, 10%, 12%, 16%, and
20%. Compute the following:
•Arithmetic Mean
= (7% + 10% + 12% + 16% + 20%) / 5 = 13%
•Geometric Mean
1/5
=...

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