A1 Business and Technical College Risk Diversification and Returns Paper & Excel Sheet Please download the file down bellow and follow the instructions.I a

A1 Business and Technical College Risk Diversification and Returns Paper & Excel Sheet Please download the file down bellow and follow the instructions.I added a pdf file for more materials.I added a sample video, Note: DO NOT use the same companies in the video. Thank you. CHAPTER 8
RISK AND RATES OF
RETURN
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
1
Learning Outcomes
LO.1 Explain what it means to take risks when
investing.
LO.2 Compute the risk and return of an
investment, and explain how the risk and
return of an investment are related.
LO.3 Identify relevant and irrelevant risk, and
explain how irrelevant risk can be reduced.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
2
Learning Outcomes (cont.)
LO.4 Describe how to determine the appropriate
reward—that is, rate of return—that investors
should earn for purchasing an investment.
LO.5 Describe actions that investors take when the
return they require to purchase an investment is
different from the return they expect the
investment to produce.
LO.5 Identify different types of risk, and classify each
as relevant or irrelevant with respect to
determining an investment’s required rate of
return.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3
Defining and Measuring Risk
○ Risk is the chance that an unexpected outcome
will occur.
○ A probability distribution is a listing of all
possible outcomes with a probability assigned
to each.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
4
Probability Distributions
○ It either will rain, or it will not rain; there are
only two possible outcomes.
Outcome
Rain
No Rain
Probability
0.40
= 40%
0.60
= 60%
1.00
100%
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
5
Probability Distributions
○ Martin Products and U. S. Electric
State of the
Economy
Boom
Normal
Recession
Probability of This
State Occurring
0.2
0.5
0.3
1.0
Rate of Return on Stock if
the Economic State Occurs
Martin Prod. U.S. Electric
110%
20%
22
16
–60
10
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
6
Expected Rate of Return
○ Rate of return expected to be realized from an
investment during its life.
○ Mean value of the probability distribution of
possible returns.
○ Weighted average of the outcomes, where the
weights are the probabilities.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
7
Expected Rate of Return
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
8
Total Risk (Stand-Alone Risk):
The Standard Deviation ()
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
9
Standard Deviation ():
Martin Products
ri – r̂
= (3)
(ri – r̂ )2
(4)
110% – 15% = 95
22 – 15 = 7
–60 – 15 = –75
9,025
49
5,625
ri
r̂
(1) – (2)
(5)
(ri – r̂ )2Pri
(4) x (5) =
0.2 9,025 x 0.2
0.5
49 x 0.5
0.3 5,625 x 0.3
Variance = σ2
(6)
= 1,805.0
=
24.5
= 1,687.5
= 3,517.0
Standard deviation = σ =
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
10
Estimated Standard Deviation, s
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
11
Measuring Risk: Coefficient of
Variation
○ Calculated as the standard deviation divided by
the expected return.
○ Useful where investments differ in risk and
expected returns.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
12
Risk Aversion and Required
Returns
○ Risk-averse investors require higher rates of
return to invest in higher-risk securities.
○ Risk Premium (RP):
❑
❑
The portion of the expected return that can be
attributed to an investment’s riskiness.
The difference between the expected rate of
return on a given risky asset and that on a less
risky asset.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
13
Risk/Return Relationship
Return
(r)
rHigh
rAvg
r = rRF + RP
rLow
Payment for Risk = Risk Premium = RP
rRF
Risk-Free Return, rRF = r* + Inflation Premium = r* + IP
0
Below Average Risk
Average Risk
Above Average Risk
Risk
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
14
Portfolio Returns
○ Expected return on a portfolio,
rˆp

The weighted average expected return on the
stocks held in the portfolio.
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distributed with a certain product or service or otherwise on a password-protected website for classroom use.
15
Portfolio Returns
○ Realized rate of return,
❑
The return that is actually earned.
❑
Actual return usually differs from expected
return.
© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
16
Portfolio Risk
○ Correlation Coefficient, 
❑
Measures the degree of relationship between two
variables.
❑
Positively correlated stocks ( > 0) have rates of
return that move in the same direction.
❑
Negatively correlated stocks (