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Presentation
on
Risk and Rates of Return
by
Dr. Sujit R. Saha
Former Professor & Director
Bangladesh Institute of Bank Management
I. Risk/ Uncertainty
– Possibility of Loss or injury
– Probability of variation in Expected outcome
= Pri Ki
Tab. 5-2
Continuous vs. Discrete Probability Distribution
Discrete: No. of Possible Outcomes is Limited
Continuous: Unlimited number of Possibilities
Fig. 5-1 ] Discrete
Fig. 5-2 ] Continuous
III. Measuring Standalone Risk: SD
Tighter the PD of Exp. returns, the less its variability
• Smaller Risk
SD/ A measure of the tightness of the Prob. Distribution
Tab. 5-3
n
(Ki K ) Pr i
^
=
v δ = 2
- 2
n
^
SD = δ = (Ki - K )Pr i
• Portfolio Beta
Weighted Av. of Ind. Securities’ betas.
p = W1 1 + W2 2 + .................. + Wn n
Example
Adding a low-beta stock would reduce the riskiness of
the portfolio.
Relationship b/w Risk and Rates of Return
For a given level of beta, what rate of return will
investors require to compensate for the risk?
Defining the Terms : jth stock
^
K j = Expected rate of Return
Kj = RRR
KRF = Risk free Rate of Return
j = Beta Coefficient
Km = Market Return or RR on Average or BA = 1.0
RPM = Km – KRF [Market Risk Premium]
RPj = (KM – KRF) j [Risk Premium on the jth stock]
Eq. 5-8
RRR/Kj = KRF + (Km – KRF) Bj
CAPM Equilibrium Pricing/SML
SML
Fig. 5-9 ] Graphical Depiction of CAPM
RRR shown on V/axis
Riskless Security ]=0
Slope of SML reflects degree of risk aversion
Steeper the Slope,
Greater the RP
Higher the RRR
Values with = 0.5, = 1.0 & = 2.0
SML and Company’s position change over time
Change in Int. Rate/ Inflation (Fig. 5-10)
Change in Risk Aversion (Fig. 5-11)
Change in Stock’s Beta (Fig. 5-11)
Thank
You
All