Slides_Fundamentals of Investments - Chapter 1 ppt

1 1 C h a p t e r A Brief History of Risk and ReturnA Brief History of Risk and Return second edition Fundamentals of Investments Valuation & Management Charles J.Corrado Bradford D.Jordan McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu @2002 by the McGraw- Hill Companies Inc.All rights reserved. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 2 Who Wants To Be A Millionaire? © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 3 A Brief History of Risk and Return Our goal in this chapter is to see what financial market history can tell us about risk and return. Goal  Two key observations emerge. c There is a reward for bearing risk, and at least on average, that reward has been substantial. d Greater rewards are accompanied by greater risks. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 4 Returns Example Total dollar return = Dividend + Capital gain on stock income (or loss) Total dollar return The return on an investment measured in dollars that accounts for all cash flows and capital gains or losses. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 5 Returns Example Percent return = Dividend + Capital gains on stock yield yield or Total dollar return . Beginning stock price Total percent return The return on an investment measured as a % of the originally invested sum that accounts for all cash flows and capital gains or losses. It is the return for each dollar invested. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 6 Returns Example: Calculating Returns  Suppose you invested $1,000 in a stock at $25 per share. After one year, the price increases to $35. For each share, you also received $2 in dividends.  Dividend yield = $2 / $25 = 8%  Capital gains yield = ($35 – $25) / $25 = 40%  Total percentage return = 8% + 40% = 48%  Total dollar return = 48% of $1,000 = $480  At the end of the year, the value of your $1,000 investment is $1,480. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 7 Work the Web  For more information on investments, check out: http://www.investorama.com  For more information on common stocks, check out: http://finance.yahoo.com http://www.nyse.com http://www.sec.gov The Historical Record: A First Look 1 - 8 McGraw Hill / Irwin The Historical Record: A Longer Range Look 1 - 9 @2002 by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin The Historical Record: A Closer Look Figure 1.3 1 - 10 @2002 by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin [...]... Second Lesson Top 12 One-Day Percentage Changes in the Dow Jones Industrial Average October 19 , 19 87 October 28, 19 29 October 29, 19 29 November 6, 19 29 December 18 , 18 99 August 12 , 19 32 McGraw Hill /Dow Jones Source: Irwin - 22.6 % - 12 .8 - 11 .7 - 9.9 - 8.7 - 8.4 March 14 , 19 07 October 26, 19 87 July 21, 19 33 October 18 , 19 37 February 1, 19 17 October 27, 19 97 - 8.3 % - 8.0 - 7.8 - 7.7 - 7.2 - 7.2 © 2002.. .1 - 11 The Historical Record: A Closer Look McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 12 The Historical Record: A Closer Look McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 13 The Historical Record: A Closer Look McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 14 The Historical... Variance of return ∑ (R − R ) N Var (R ) = σ = 2 i =1 2 i N 1 where N is the number of returns Standard deviation of return SD (R ) = σ = Var (R ) McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved Return Variability: The Second Lesson 1 - 24 1 - 25 Return Variability: The Second Lesson McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 26... All rights reserved 1 - 17 Average Returns: The First Lesson McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 18 Average Returns: The First Lesson Risk-free rate The rate of return on a riskless investment Risk premium The extra return on a risky asset over the risk-free rate; the reward for bearing risk McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc... reserved 1 - 19 Average Returns: The First Lesson McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 20 Average Returns: The First Lesson The First Lesson There is a reward, on average, for bearing risk McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 21 Return Variability: The Second Lesson McGraw Hill / Irwin @2002 by the McGraw- Hill... Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 15 Work the Web To learn more about global market history, visit: http://www.globalfindata.com McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 16 Average Returns: The First Lesson Average annual = Σ yearly returns return number of years McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc... - 7.7 - 7.2 - 7.2 © 2002 by The McGraw- Hill Companies, Inc.All rights reserved @2002 by the McGraw-Hill Companies Inc All rights reserved 1 - 29 Risk and Return McGraw Hill / Irwin @2002 by the McGraw- Hill Companies Inc.All rights reserved 1 - 30 Risk and Return The risk-free rate represents compensation for just waiting So, it is often called the time value of money If we are willing to bear risk,... Work the Web For an easy-to-read review of basic statistics, see: http://www.robertniles.com/stats/ McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 27 Return Variability: The Second Lesson The Second Lesson The greater the potential reward, the greater the risk McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 28 Return Variability:... Inc.All rights reserved 1 - 22 Return Variability: The Second Lesson Variance A common measure of volatility Standard deviation The square root of the variance Normal distribution A symmetric, bell-shaped frequency distribution that is completely defined by its average and standard deviation McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 23 Return Variability:... / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights reserved 1 - 34 Chapter Review Return Variability: The Second Lesson Frequency Distributions and Variability The Historical Variance and Standard Deviation The Historical Record Normal Distribution The Second Lesson Risk and Return The Risk-Return Trade-Off A Look Ahead McGraw Hill / Irwin © 2002 by The McGraw-Hill Companies, Inc All rights . Closer Look Figure 1. 3 1 - 10 @2002 by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin The Historical Record: A Closer Look 1 - 11 @2002 by the McGraw- Hill Companies Inc.All. return = 48% of $1, 000 = $480  At the end of the year, the value of your $1, 000 investment is $1, 480. © 2002 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw Hill / Irwin 1 - 7 Work. Record: A Closer Look 1 - 12 @2002 by the McGraw- Hill Companies Inc.All rights reserved. McGraw Hill / Irwin The Historical Record: A Closer Look 1 - 13 @2002 by the McGraw- Hill Companies Inc.All