8 views

Original Title: Ch_04

Uploaded by rahulrockon

- screener1.pdf
- Security Analysis and Portfolio Management 1220943486455568 9
- SL1 Sma Dec2012
- 1. Jecr-using Disparate Market Data to Measure and Predict Future Performance of Commercial
- Ex. Chapter 7
- 1. Risk and Return-1
- H&SA 02 Ordinary Lives-CSR
- 4. Global Performance Evaluation
- Research on Investment KSE 100 Index Pakistan
- Social Security: v63n2p38
- Financial Mgt
- ACC 206 Week 5 Problems Calculate the Present Value of the Following Cash Flows
- Optimal funding of pension schemes
- Security Analysis and Portfolio Management 1220943486455568 9
- CF Assignment
- Merits of CFROI
- Data Analysis
- Almost300SolvedMCQsofACC501
- Financial Analysis and Management
- Financial Statement Analysis Project Qualitative Analysis

You are on page 1of 11

Overview of Capital

Market Theory

Chapter Objectives

Discuss the concepts of average and expected rates

of return.

Define and measure risk for individual assets.

Show the steps in the calculation of standard

deviation and variance of returns.

Explain the concept of normal distribution and the

importance of standard deviation.

Compute historical average return of securities and

market premium.

Determine the relationship between risk and return.

Highlight the difference between relevant and

irrelevant risks.

Vikas Publishing House Pvt. Ltd.

Return on a Single Asset

Total return

Rate of return = Dividend yield + Capital gain yield

= Dividend DIV1 P1 − P0 DIV1 + ( P1 − P0 )

+ Capital R1 =

P0

+

P0

=

P0

gain

160.00 149.70

140.00

120.00

100.00 92.33

70.54

Year-to-

80.00

60.00 49.52 52.64

36.13

40.00 22.71

16.52 12.95

20.00 7.29

Year Total

0.00

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Year

Returns on

HLL Share

Vikas Publishing House Pvt. Ltd.

Average Rate of Return

The average rate of return is the sum of the

various one-period rates of return divided by

the number of period.

Formula for the average rate of return is as

follows:

n

1 1

R = [ R1 + R 2 + L + R n ] =

n n

∑R t

t =1

Vikas Publishing House Pvt. Ltd.

Risk of Rates of Return: Variance

and Standard Deviation

Formulae for calculating variance and

standard deviation:

Standard deviation = Variance

( )

n 2

1

σ2 = ∑

n − 1 t =1

Rt − R

Vikas Publishing House Pvt. Ltd.

Investment Worth of Different

Portfolios, 1969–70 to 1997–98

Index

100

Call Money Market 57.16

Long-termGovt. Bonds

Inflation

91-day TB 13.99

10.36

10 10.20

4.41

1

Year

1972-73

1974-75

1976-77

1978-79

1980-81

1982-83

1990-91

1992-93

1993-94

1995-96

1997-98

1969-70

1971-72

1973-74

1975-76

1977-78

1979-80

1981-82

1983-84

1984-85

1985-86

1986-87

1987-88

1988-89

1989-90

1991-92

1994-95

1996-97

1970-71

Vikas Publishing House Pvt. Ltd.

Averages and Standard Deviations,

1970–71 to 1997–98

Arithmetic Standard Risk Risk

Securities mean deviation premium* premium#

Call money market 9.93 3.49 4.47 1.19

Long -term government bonds 8.74 2.59 3.28

91-Day treasury bills 5.46 2.05

Inflation 8.80 5.82

Vikas Publishing House Pvt. Ltd.

Expected Return : Incorporating

Probabilities in Estimates

The expected

RETURNS UNDER VARIOUS ECONOMIC CONDITIONS

(1)

Share Price

(2)

Dividend

(3)

Dividend Yield

(4)

Capital Gain

(5)

Return

(6) = (4) + (5)

[E (R)] is the

High growth 305.50 4.00 0.015 0.169 0.185

Expansion 285.50 3.25 0.012 0.093 0.105

Stagnation 261.25 2.50 0.010 0.000 0.010

sum of the

Decline 243.50 2.00 0.008 – 0.068 – 0.060

product of

each outcome

(return) and its RETURNS ANDPROBABILITIES

associated

Economic Conditions Rate of Return (%) Probability Expected Rate of Return (%)

(1) (2) (3) (4) = (2) × (3)

Growth 18.5 0.25 4.63

probability: Expansion

Stagnation

Decline

10.5

1.0

– 6.0

0.25

0.25

0.25

2.62

0.25

– 1.50

1.00 6.00

Vikas Publishing House Pvt. Ltd.

Expected Risk and Preference

The following formula can be used to

calculate the variance of returns:

σ 2 = R1 − E ( R 2 ) P1 + R2 − E ( R 2 ) P2 + ... + Rn − E ( R 2 ) Pn

n

= ∑ Ri − E ( R 2 ) Pi

i =1

Vikas Publishing House Pvt. Ltd.

Expected Risk and Preference

A risk-averse investor will choose among

investments with the equal rates of return, the

investment with lowest standard deviation.

Similarly, if investments have equal risk

(standard deviations), the investor would prefer

the one with higher return.

A risk-neutral investor does not consider risk,

and would always prefer investments with higher

returns.

A risk-seeking investor likes investments with

higher risk irrespective of the rates of return. In

reality, most (if not all) investors are risk-averse.

Financial Management, Ninth Edition © I M Pandey 10

Vikas Publishing House Pvt. Ltd.

Normal Distribution

Normal distribution is an important concept in

statistics and finance. In explaining the risk-

return relationship, we assume that returns

are normally distributed.

Normal distribution is a population-based,

theoretical distribution.

Vikas Publishing House Pvt. Ltd.

- screener1.pdfUploaded byzorg
- Security Analysis and Portfolio Management 1220943486455568 9Uploaded byHarshavardhan Reddy
- SL1 Sma Dec2012Uploaded byBrittney Lee
- 1. Jecr-using Disparate Market Data to Measure and Predict Future Performance of CommercialUploaded byTJPRC Publications
- Ex. Chapter 7Uploaded byren 76
- 1. Risk and Return-1Uploaded byMarri Denyel Cordeta
- H&SA 02 Ordinary Lives-CSRUploaded byHousing and Support Alliance
- 4. Global Performance EvaluationUploaded bykusi786
- Research on Investment KSE 100 Index PakistanUploaded byMudassar Iqbal
- Social Security: v63n2p38Uploaded bySocial Security
- Financial MgtUploaded byDaodu Ladi Busuyi
- ACC 206 Week 5 Problems Calculate the Present Value of the Following Cash FlowsUploaded byKathy Chugg
- Optimal funding of pension schemesUploaded byjjvargasz
- Security Analysis and Portfolio Management 1220943486455568 9Uploaded byAparna Appu
- CF AssignmentUploaded byharsha sharath
- Merits of CFROIUploaded byfreemind3682
- Data AnalysisUploaded byNZ MA
- Almost300SolvedMCQsofACC501Uploaded byHammad Azam Jathol
- Financial Analysis and ManagementUploaded byr
- Financial Statement Analysis Project Qualitative AnalysisUploaded byJohn OMalley
- Fear in Children and AdolescentsUploaded byrockamkd
- Interim Letter to Investors Year 4Uploaded byVictor Febriant
- R - Scatter Plot With Error Bars - Stack OverflowUploaded byAlisson Costa
- NDE 6310 Assignment 1Uploaded byMathew John
- What is Mean by an InvestmentUploaded byإبداع كروي
- FinQuiz-Level1Mock2016Version1JuneAMQuestions (1).pdfUploaded byAnimesh Choubey
- 37118528Uploaded byLeonardoAlejandroMingari
- What Has Worked in InvestingUploaded byDomie-Neil Salas
- PS_4Uploaded byGilbert Ansah Yirenkyi
- F18Uploaded byIjaz Haider

- UBS Spreadsheet DataUploaded bydhandadhan
- The U.S. Constitution and Money Part 6 The Legal Tender CasesUploaded bymichael s rozeff
- Stock Investing and Trading Best Techniques - Garrys Guide to Becoming a Millionaire in the Financial MarketsUploaded byadrian_grigor
- Shake Shack - Free Writing ProspectusUploaded bymorgan969
- 09_09_11_case1Uploaded bySumit Shingala
- Factorii Determinanti Ai Profitabilitatii Bancilor in Tarile in TranzitieUploaded byMaciuca Dorinel
- TILA presentation slides from the Mortgage Bankers AssociationUploaded by83jjmack
- David+Jones+Financial+AnalysisUploaded byJason
- NCDsUploaded byskr
- Notes on Essays of Warren BuffetUploaded byjimingli
- FS Analysis on Cebu PacificUploaded byIvan Bendiola
- Comment on the Wörgl Experiment With Community Currency and DemurrageUploaded bysinnombrepues
- What Does Inflation MeanUploaded bypuran1983
- 3- GDPUploaded byAnnreetha Anthony
- k48_anh 2 Clctcnh_le Anh MinhUploaded byMinh Anh
- General LedgerUploaded byfharooks
- um-fi-05-cash journalUploaded byapi-285774970
- Modification FormUploaded byAniket Pandey
- CGTMSEUploaded bym_gadhvi6840
- Corporate Finance LSEUploaded bySharon Manzini
- CSC - Chapter 1Uploaded byRichmond Lau
- 408-2012-Lec03 DCF1Uploaded byThyago Oliveira
- Proceedings of the ICES Conference and Academic Day 2012Uploaded byHaryanto Hary
- Commodities_Risk Management InstrumentsUploaded byAnna Kruglova
- United States v. Philadelphia Nat. Bank, 374 U.S. 321 (1963)Uploaded byScribd Government Docs
- DerivativesUploaded byDhaval Dedhia
- chap014Answers.docUploaded bySylvia Grace
- Causes of InflationUploaded byŚáńtőśh Mőkáśhí
- S.I & C.IUploaded byAnonymous ZVbwfc
- Restated Satyam Balance SheetUploaded byHarish