PowerPoint to accompany Chapter 5 Risk & Return Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Learning Goals: Understand the meaning of risk, return and risk preferences. Measure the risk and return of a single asset. Measure the risk and return of a portfolio of assets. Explain beta and the CAPM model. Analyse shifts in the securities market line. Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Fundamentals Of Risk Risk is defined as “the chance of financial loss”. Refers to the variability of returns associated with a given asset. Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Sources Of Risk Sources include: Business Financial Interest Rate Liquidity Market Event Exchange Rate Purchasing Power Tax Moral Firm Specific Risks table05-01.jpg Shareholder Specific Risks Firm & Shareholder Risks Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Fundamentals Of Return Return is defined as “the total gain or loss experienced on an investment over a given period of time”. Is measured as cash distributions during the period, plus the change in value, expressed as a percentage of the investment value at the beginning of the period. Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Calculated using the formula: r t = C t + (P t – P t-1 ) [Equation 5.1] P t-1 Where: r t = Actual, expected or required rate of return during the period t C t = Cash flow received from the investment in the time period [t – 1 to t] P t = Price of the asset at time t P t-1 = Price of the asset at time t - 1 Fundamentals Of Return Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Calculating Return Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Historical Returns Allows for analysis of the differences in return that are attributable primarily to the types of investment. Shows the average annual rate of return for each investment. Categories include: Australian Shares International Shares Australian Bonds International Bonds Listed Property Cash Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Risk Preferences Three Preferences: 1. Risk Averse: Require a higher rate of return to compensate for taking higher risk. 2. Risk Seeking: Will accept a lower return for a greater risk. 3. Risk Indifferent: Required return does not change in response to a change in risk. Copyright © 2011 Pearson Australia (a division of Pearson Australia Group Pty Ltd) – 9781442518193/ Gitman et al / Principles of Managerial Finance / 6th edition Risk Preferences Page 211.