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.