CHAPTER 8: Risk and Rates of Return
Updated: September 20, 2011
All Financial Assets Produce CFs Risk of Asset Depends on Risk of CFs Stand-alone Risk of Asset’s CFs Portfolio Risk of CFs
Diversifiable and Market Risk
Risk & return: CAPM / SML
The rate of return on an investment can be calculated as follows:
(Amount received – Amount invested) ________________________
For example, if $1,000 is invested and $1,100 is returned after one year, the rate of return for this investment is: ($1,100 - $1,000) / $1,000 = 10%.
What is investment risk?
Two types of investment risk
Stand-alone risk Portfolio risk
Investment risk is related to the probability of earning a low or negative actual return. The greater the chance of lower than expected or negative returns, the riskier the investment. Risk = Dispersion of Returns around mean, or expected mean: variance or standard deviation