# Finance 325 Chapter 9

 This is a measure summarizing the overall past performance of an investment Average Return T or F: When people purchase a stock, they do not know what their return is going to be -either short term or in the long term run True This is defined as the volatility of an investment, which includes firm specific risk as well as market risk Total Risk This is defined as a combination of investment assets held by an investor Portfolio This is defined as the portion of total risk that is attributable to firm or industry factors and can be reduced through diversification Firm Specific Risk This is the portion of total risk that is attributable to overall economic factors Market Risk This is the term for portfolios with the highest return possible for each risk level Efficient Portfolios This is a measurement of the co-movement between two variables that range between -1 and +1 Correlation T or F: The larger the standard deviation, the higher the total risk True Investment Return: MedTech Corp stock was \$51.65 per share at the end of last year. Since then, it paid a \$1.15 per share dividend. The stock price is currently \$63.20. If you owned 100 shares of MedTech, what was your percent return? 24.59% Portfolio Weights: An investor owns \$10,000 of Adobe Systems stock, \$15,000 of Dow Chemical, and \$25,000 of Office Depot. What are the portfolio weights of each stock? Adobe system = 0.20, Dow Chemical = 0.30, Office Depot = 0.50 Portfolio Return: Year-to-date, Company O had earned a -2.70 percent return. During the same time period, Company V earned 8.6 percent and Company M earned 6.85 percent. If you have a portfolio made up of 20 percent Company O, 10 percent Company V, and 70 percent Company M, what is your portfolio return? 5.115% Average Return: The past five monthly returns for K and Company are 4.55 percent, 4.43 percent, -1.75 percent, 3.55 percent, and 7.55 percent. What is the average monthly return? 3.666% Portfolio Weights: If you own 600 shares of Air Line Inc at \$41.5, 200 shares of BuyRite at \$54.75, and 300 shares of Motor City at \$8.8, what are the portfolio weights of each stock? Air Line = 0.6472, BuyRite = 0.2846, MotorCity = 0.0682 Portfolio Return: At the beginning of the month, you owned \$6,000 of Company G, \$8,100 of Company S, and \$1,200 of Company N. The monthly returns for Company G, Company S, and Company N were 7.35 percent, -1.51 percent, and -.22 percent. What is your portfolio return? 2.05% Metod for calculating returns Dollar ReturnsPercentage Returns Dollar Return Includes capital gain or loss as well as income= Capital gain or loss + income= (ending value – beginning value) + income Percentage Returns -Returns across different investments are more easily compared because they are standardized-can be used for most types of investments=(Ending value – beginning value + Income) / Beginning Value x 100% =Capital gain yield + dividend yield Example: You held 250 shares of Hilton Hotel’s common stock. The company’s share price was \$24.11 at the beginning of the year. During the year, the company paid a dividend of \$0.16 per share, and ended the year at a price of \$34.90. What is the dollar return, the percentage return, the capital gains yield, and the dividend yield for Hilton? Dollar return = 250 x (\$34.90-\$24.11+\$0.16) = \$2,737.50Percent return = (\$34.90-\$24.11+\$0.16)/\$24.11 = 45.42%Capital gains yield = (\$34.90 – \$24.11)/\$24.11 = 44.75%Dividend yield = \$0.16/\$24.11 = 0.66% Computing Volatility -The larger the standard deviation, the higher the risk-Represents the total risk of a security or portfolio Standard Deviation (equation for computing volatility) = square root of the average deviation of returns Risk Vs. Return *With any investment, risk/return tradeoff*coefficient of variation (CoV) is a relative measure of this relation ship–amount of risk(measured by volatility) per unit of return Coefficient of variation equation Coefficient of variation equation = amount of risk / return=standard deviation / average return To main components of total risk Total Risk = Firm-specific risk + Market risk Firm-Specific risk referred to as diversifiable risk Market risk is non-diversifiable risk. This risk applies across all securities in any given market Modern Porftolio Theory -Risk is reduced when securities are combined-The optimal portfolio is the combination of securities that product the highest return for the amount of risk taken Adding stocks to a portfolio ________ risk reduces Diversification -When stocks’ return are not perfectly correlated–price movements often counteract each other -With perfect positive correlation, diversification does not affect risk Efficient Portfolios Portfolios with the highest return possible for reach risk level Efficient Frontier If we added all available securities to the graph, then all of the efficient portfolios of those securities would form this Efficient frontier portfolios ______________ all other possible stock portfolios dominate How does diversification work? *Correlation measures the tendency of two stock’s returns to move together, and is represented by pA,B -1.0 =< p =< +1.0*Perfect positive correlation means pA,B = +1.0; returns from two stocks are perfectly in sync*Perfect negative correlation means pA,B = -1.0; returns from two stocks move exactly opposite Portfolio Return Return Calculation*Rp= (Proportion of portfolio in first stock x that stock’s return) + (second stock portion x second stock return) + … = (w1 x R1) + (w2 x R2) + (w3 x R3) + …( wn x Rn) Example: At the beginning of 2007 you owned \$5,000 of Disney stock, \$10,000 of Bank of New York stock, and \$15,000 of IBM stock. In 2007, the three company’s returns were -4.8 percent, 19.4 percent, and 12.8 percent respectively. What is your portfolio return?Stock:Disney, Bank of New York, IBMAmount invested: \$5,000, \$10,000, \$15,000Weight Calculation: 5,000/30,000; 10,000/30,000; 15,000/30,000Weight: 0.1667; 0.3333; 0.50 Rp = (0.1667 x-4.8%) + (0.3333 x 19.4%) + (0.5 x 12.8%)= 12.07%
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