kam ki finance

Slide 1: 

Chapter 7 Introduction to Risk, Return, and The Opportunity Cost of Capital Principles of Corporate Finance Eighth Edition Slides by Matthew Will Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved McGraw-Hill/Irwin

Topics Covered : 

Topics Covered Over a Century of Capital Market History Measuring Portfolio Risk Calculating Portfolio Risk Beta and Unique Risk Diversification & Value Additivity

Slide 3: 

The Value of an Investment of $1 in 1900

The Value of an investment of Rs.1 in 1978-79 : 

The Value of an investment of Rs.1 in 1978-79

Slide 5: 

The Value of an Investment of $1 in 1900 Real Returns

The Value of an investment of Rs.1 in 1978-79 : 

The Value of an investment of Rs.1 in 1978-79

Average Market Risk Premia (by country) : 

Average Market Risk Premia (by country) Risk premium, % Country Sensex has registered an excess return of about 13% in the last 26 years.

Slide 8: 

Rates of Return 1900-2003 Source: Ibbotson Associates Year Percentage Return US Stock Market Index Returns

Measuring Risk : 

Measuring Risk Return % # of Years Histogram of Annual US Stock Market Returns

Stock Index Returns in India (1979-2005) : 

Stock Index Returns in India (1979-2005)

Measuring Risk : 

Measuring Risk Variance - Average value of squared deviations from mean. A measure of volatility. Standard Deviation - Average value of squared deviations from mean. A measure of volatility.

Measuring Risk : 

Measuring Risk Coin Toss Game-calculating variance and standard deviation For each head, you get the starting balance plus 30%; For each tail, you get your starting balance less 10%.

Measuring Risk : 

Measuring Risk Diversification - Strategy designed to reduce risk by spreading the portfolio across many investments. Unique Risk - Risk factors affecting only that firm. Also called “diversifiable risk.” Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”

Measuring Risk : 

Measuring Risk

Measuring Risk : 

Measuring Risk

Measuring Risk : 

Measuring Risk

Portfolio Risk : 

Portfolio Risk The variance of a two stock portfolio is the sum of these four boxes

Portfolio Risk : 

Portfolio Risk Example Suppose you invest 47% of your portfolio in Reliance Energy and 53% in Grasim Industries. The expected return on your Reliance Energy stock is 17% and on Grasim is 14%. The expected return on your portfolio is:

Portfolio Risk : 

Portfolio Risk Example Suppose you invest 47% of your portfolio in Reliance Energy and 53% in Grasim Industries. The expected return on your Reliance Energy stock is 17% and on Grasim is 14%. The standard deviation of their annualized daily returns are 37% and 33%, respectively. Assume a correlation coefficient of 1.0 and calculate the portfolio variance.

Portfolio Risk : 

Portfolio Risk Example Suppose you invest 47% of your portfolio in Reliance Energy and 53% in Grasim Industries. The expected return on your Reliance Energy stock is 17% and on Grasim is 14%. The standard deviation of their annualized daily returns are 37% and 33%, respectively. Assume a correlation coefficient of 1.0 and calculate the portfolio variance. Portfolio variance = [(0.47)2  (37)2] + [(0.53)2  (33)2] +2 (0.47  0.53  1  33  37) = 1216.61

Portfolio Risk : 

Portfolio Risk

Portfolio Risk : 

Portfolio Risk The shaded boxes contain variance terms; the remainder contain covariance terms. STOCK STOCK To calculate portfolio variance add up the boxes

Beta and Unique Risk : 

Beta and Unique Risk 1. Total risk = diversifiable risk + market risk 2. Market risk is measured by beta, the sensitivity to market changes

Beta and Unique Risk : 

Beta and Unique Risk Market Portfolio - Portfolio of all assets in the economy. In practice a broad stock market index, such as the Nifty or Sensex, is used to represent the market. Beta - Sensitivity of a stock’s return to the return on the market portfolio.

Beta and Unique Risk : 

Beta and Unique Risk

Beta and Unique Risk : 

Beta and Unique Risk Covariance with the market Variance of the market

Web Resources : 

Web Resources www.globalfindata.com www.econ.yale.edu/~shiller Click to access web sites Internet connection required Web Links