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Ch-6 - Risk & Return

This chapter discusses key concepts related to analyzing investment risk and return. It defines return as consisting of income and capital gain/loss components. It explains how to calculate returns in percentage terms using dividend yield, capital gains yield, and total return. The chapter also discusses how to measure risk using variance, standard deviation, and the difference between systematic and unsystematic risk. Finally, it distinguishes between nominal and real rates of return and how inflation affects these calculations.

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Tas Mima
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57 views

Ch-6 - Risk & Return

This chapter discusses key concepts related to analyzing investment risk and return. It defines return as consisting of income and capital gain/loss components. It explains how to calculate returns in percentage terms using dividend yield, capital gains yield, and total return. The chapter also discusses how to measure risk using variance, standard deviation, and the difference between systematic and unsystematic risk. Finally, it distinguishes between nominal and real rates of return and how inflation affects these calculations.

Uploaded by

Tas Mima
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 6:

Analysis of
Risk &
Return
I m ro z M a h m u d
A s s i s t a n t P ro f e s s o r ( UA P )
LEARNING OBJECTIVES

LO-1: Components of return

LO-2: How to calculate return from historical / past data

LO-3: How to calculate risk using historical / past data

LO-4: Nominal vs. Real Return

Prepared by Imroz Mahmud


INTRODUCTION

 If you buy an asset of any sort, your gain (or loss) from that investment is
called the return
 Return is closely associated with……….?
 The required return/reward depends on the risk of the investment.

The greater the risk, the greater is the required return/potential reward

Prepared by Imroz Mahmud


RETURNS

 Return has two components:


o Income component
o Capital gain (or loss) component
Example 1: Video Concept Company (VCC) has several thousand shares of stock
outstanding. You purchased 100 shares in the company at the beginning of the year for
$37 per share. Suppose that, over the year, the stock paid a dividend of $1.85 per share.
Also, the value of the stock has risen to $40.33 per share by the end of the year.
 What’s your income (dividend) gain?
 What’s your capital gain? Total gain?

Prepared by Imroz Mahmud


PERCENTAGE RETURNS

 It is usually more convenient to summarize information about returns in percentage


terms, rather than dollar terms.
 Express everything on per-share basis

 Income gain:
𝐷𝑡+1
▪ 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑌𝑖𝑒𝑙𝑑 =
𝑃𝑡
▪ 𝑃𝑡 = 𝐵𝑒𝑔𝑖𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒
▪ 𝐷𝑡+1 = 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑎𝑖𝑑 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟

Prepared by Imroz Mahmud


PERCENTAGE RETURNS

 Capital gain (or loss):


Pt+1 −Pt
• Capital Gains Yield =
Pt
• 𝑃𝑡 = 𝐵𝑒𝑔𝑖𝑛𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒
• 𝑃𝑡+1 = 𝐸𝑛𝑑𝑖𝑛𝑔 𝑠𝑡𝑜𝑐𝑘 𝑝𝑟𝑖𝑐𝑒

• Total Return= Dividend Yield + Capital Gains Yield

Prepared by Imroz Mahmud


EXAMPLE 2: CALCULATING RETURNS

 Suppose you bought some stock at the beginning of the year for Tk.
3801.40 per share. At the end of the year, the price is Tk. 4,442.60 per
share. During the year, you got a Tk. 140 dividend per share. What is the
dividend yield? The capital gains yield? The percentage return?
 If your total investment was Tk. 100,000, how much do you have at the
end of the year?

Prepared by Imroz Mahmud


AVERAGE RETURNS

 The history of capital market returns is too complicated to be of much use in its
undigested form
 Therefore, we take average returns
σ 𝑅𝑖
 Formula: ത
𝑅=
𝑛
• 𝑅𝑖 = 𝑎𝑐𝑡𝑢𝑎𝑙 𝑟𝑒𝑡𝑢𝑟𝑛
• 𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑏𝑠𝑒𝑟𝑣𝑎𝑡𝑖𝑜𝑛𝑠
• 𝑅ത = 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑒𝑡𝑢𝑟𝑛

Prepared by Imroz Mahmud


CALCULATING RISK

 Measured using the variability of stock’s return


 How much actual returns deviate from the average?
 Variance, 𝜎 2
 Standard Deviation, 𝜎
 The bigger the variance/standard deviation, the more the actual return differs from
average returns.
 There is more risk.

Prepared by Imroz Mahmud


CALCULATING RISK

 Variance:
2
σ 𝑅𝑖 − ത
𝑅
𝑉𝑎𝑟 𝑅 𝑜𝑟 𝜎 2 =
𝑛−1
 Standard Deviation:
2
ത
σ(𝑅𝑖 − 𝑅)
𝑆𝐷 𝑅 𝑜𝑟 𝜎 =
𝑛−1
Prepared by Imroz Mahmud
EXAMPLE 3: CALCULATING RISK AND RETURN

 Suppose the Supertech Company and the Hyperdrive Company have experienced the
following returns in the last four years:
Year Supertech Hyperdrive
Return Return
2017 (20%) 5%
2018 50% 9%
2019 30% (12%)
2020 10% 20%

 What are the average returns? The variances? The standard deviations?
 Which investment was more volatile/risky?

Prepared by Imroz Mahmud


RISK: SYSTEMATIC AND UNSYSTEMATIC

 True risk of an investment is the unanticipated part of the return.


 Systematic Risk: a risk that influences a large number of assets.
 Also called market risk
 Can’t be avoided through diversification

 Unsystematic Risk is unique to a specific company or industry.


 Also called diversifiable risk / asset specific risk

Prepared by Imroz Mahmud


NOMINAL VS. REAL RATES

 Real Rates: Interest rates or rates of return that have been adjusted for inflation.
 Shows percentage change in your purchasing power

 Nominal Rates: Interest rates or rates of return that have not been adjusted for
inflation.
 Shows percentage change in the amount of money you have

 Investors are ultimately concerned with what they can buy with their money.

Prepared by Imroz Mahmud


THE FISHER EFFECT

 Shows the relationship between nominal returns, real returns and inflation.

1+𝑅
𝑟= −1
1+𝑖

 Example 4: For Example 3, suppose the average inflation rate over this period was 4
percent. Then, what was the real return?
 Example 5:You own an asset that had a total return last year of 10.7 percent. If the
inflation rate last year was 3.7 percent, what was your real return?
Prepared by Imroz Mahmud
End of Chapter

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