Rangkuman Bab 6 dan 7

Indah Olivia Ambarita

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Return and Risk

THE TWO COMPONENTS OF ASSET RETURNS :

Yield: The basic component many investors think of when discussing investing returns is the periodic cash flows (or
income) on the investment also measures a security’s cash flows relative to some price, such as the purchase price or
the current market price.

Capital gain (loss): The second component is the appreciation (or depreciation) in the price of the asset, commonly
called the capital gain (loss).

TOTAL RETURN, is the basic measure of the return earned by investors on any financial asset for any
specified period of time. It can be stated on a decimal or percentage basis.

To calculate total return bond, using Interest payment period.

To calculate total return of Stock, using dividend paid during the period.

To calculate total return of warrant, using any cash payment received by the warrant holder during the
period.

RETURN RELATIVE, eliminates negative numbers by adding 1.0 to the TR. It provides the same information as the
TR, but in a different form.

CUMULATIVE WEALTH INDEX, to measure how one’s wealth in dollars changes over time also used as the initial
investment.

INTERNATIONAL RETURNS AND CURRENCY RISK

Calculating currency- adjusted return

SUMMARY STATISTICS OF RETURN

1. Aritmethic Return (most common)

2. Geometric Return, measures the compound rate of growth over time. It is important because geometric
mean assumes that all cash flows are reinvested in the asset and that those reinvested funds earn the
subsequent rates of return available on that asset for some specified period.

The arithmetic mean is a better measure of average (typical) performance over single periods. It is the best estimate
of the expected return for next period.

The geometric mean is a better measure of the change in wealth over the past (multiple periods). It is typically used
by investors to measure the realized compound rate of return at which money grew over a specified period of time.
THE CONSUMER PRICE INDEX, used to measure of inflation.

To calculation the inflation, we can calculate inflation-adjusted returns by dividing 1 + (nominal)total return by 1+
the inflation rate as shown

RISK, as the chance that the actual outcome from an investment will differ from the expected outcome.
Sources of Risk :
1. Interest Rate Risk
2. Market Risk
3. Inflation Risk
4. Bussines Risk
5. Financial Risk
6. Liquidity Risk
7. Currency Risk (Exchange Rate Risk)
8. Country Risk

MEASURING RISK
Variance and Standar Deviation, provides useful information about the distribution of returns and aids investors in
assessing the possible outcomes of an investment.
RISK PREMIUMS, the additional return investors expect to receive, or did receive, by taking on increasing amounts
of risk. It measures the payoff for taking various types of risk.
Calculating the Equity Risk Premium There are alternative ways to calculate the equity risk premium, involving
arithmetic means, geometric means, Treasury bonds, and so forth.
It can be calculated as
1. Equities minus Treasury bills, using the arithmetic mean or the geometric mean
2. Equities minus long-term Treasury bonds, using the arithmetic mean or the geometric mean

REALIZED RETURNS AND RISKS FROM INVESTING

Total returns and standard deviations for the major financial assets.

UNDERSTANDING CUMULATIVE WEALTH AS INVESTORS, The CWI can be decomposed into the two
components of Total Return: the dividend component and the price change component.

PORTFOLIO THEORY IS UNIVERSAL

DEALING WITH UNCERTAINTY

Risk that expected return will not be realized Investors must think about return distributions, not just a single return.
Probabilities weight outcomes :
1. Should be assigned to each possible outcome to create a distribution
2. Can be discrete or continuous

CALCULATING EXPECTED RETURN FOR A SECURITY, to describe the single most likely outcome from a
particular probability distribution.

CALCULATING RISK FOR A SECURITY, The tighter the probability distribution of expected returns, the smaller the
standard deviation, and the smaller the risk.
PORTFOLIO EXPECTED RETURN, is the percentages of a portfolio’s total value that are invested in each
portfolio asset on any portfolio can be calculated as a weighted average of the individual securities expected returns.

CORRELATION COEFFICIENT, is a statistical measure of the relative co-movements between security returns.

COVARIANCE, is an absolute measure of the degree of association between the returns for a pair of securities.

1. Positive, indicating that the returns on the two securities tend to move in the same direction at the same time;
when one increases (decreases), the other tends to do the same. When the covariance is positive, the correlation
coefficient will also be positive.

2. Negative, indicating that the returns on the two securities tend to move inversely; when one increases (decreases),
the other tends to decrease (increase). When the covariance is negative, the correlation coefficient will also be
negative.

3. Zero, indicating that the returns on two securities are independent and have no tendency to move in the same or
opposite directions together.

RELATING THE CORRELATION COEFFICIENT AND THE COVARIANCE

Knowing the correlation coefficient, we can calculate the covariance because the standard deviations of the assets’
rates of return will already be available. Knowing the covariance, we can easily calculate the correlation coefficient.
When analyzing how security returns move together, it is always convenient to talk about the correlation coefficients
because we can immediately assess the degree of association (the boundaries are +1 and -1).

THE TWO-SECURITY CASE, The risk of a portfolio, as measured by the standard deviation of returns.

The Importance of Covariance is important contributions to portfolio theory is his insight about the relative
importance of the variances and covariances.

When we add a new security to a large portfolio of securities, there are two impacts.
1. The asset’s own risk, as measured by its variance, is added to the portfolio’s risk.
2. A covariance between the new security and every other security already in the portfolio
is also added.