07 Introduction to Risk, Return, and the Opportunity Cost of Capital

1、Principles of Corporate FinanceSeventh EditionRichard A. Brealey Stewart C. MyersSlides byMatthew WillChapter 7McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Introduction to Risk, Return, and the Opportunity Cost of Capital7- 2McGraw Hill/IrwinCopyright 2003 b

2、y The McGraw-Hill Companies, Inc. All rights reserved Topics Coveredw 75 Years of Capital Market Historyw Measuring Riskw Portfolio Riskw Beta and Unique Riskw Diversification7- 3McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved The Value of an Investment of $1 i

3、n 1926Source: Ibbotson Associates0.1101000192519401955197019852000S&PSmall CapCorp BondsLong BondT BillIndexYear End16402258764.148.916.67- 4McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved 0.1101000192519401955197019852000S&PSmall CapCorp BondsLong Bond

4、T BillSource: Ibbotson AssociatesIndexYear End16602676.65.01.7Real returnsThe Value of an Investment of $1 in 19267- 5McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Rates of Return 1926-2000Source: Ibbotson Associates-60-40-200204060263035404550556065707580859

5、0952000Common StocksLong T-BondsT-BillsYearPercentage Return7- 6McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Average Market Risk Premia (1999-2000)4.35.166.1 6.16.56.77.17.588.59.99.9101101234567891011DenBelCanSwiSpaUKIreNethUSASweAusGerFraJapItRisk premium,

6、 %Country 7- 7McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring RiskVariance - Average value of squared deviations from mean. A measure of volatility.Standard Deviation - Average value of squared deviations from mean. A measure of volatility.7- 8McGraw

7、Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring RiskCoin Toss Game-calculating variance and standard deviation(1)(2)(3)Percent Rate of ReturnDeviation from MeanSquared Deviation+ 40+ 30900+ 1000+ 1000- 20- 30900Variance = average of squared deviations = 1800

8、 / 4 = 450Standard deviation = square of root variance =450 = 21.2%7- 9McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring Risk1124131113121332012345678910111213-50 to -40-40 to -30-30 to -20-20 to -10-10 to 00 to 1010 to 2020 to 3030 to 4040 to 5050 to 6

9、0Return %# of Years7- 10McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring RiskDiversification - Strategy designed to reduce risk by spreading the portfolio across many investments.Unique Risk - Risk factors affecting only that firm. Also called “diversi

10、fiable risk.”Market Risk - Economy-wide sources of risk that affect the overall stock market. Also called “systematic risk.”7- 11McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring RiskPortfolio rateof return=fraction of portfolioin first assetxrate of re

11、turnon first asset+fraction of portfolioin second assetxrate of returnon second asset()7- 12McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Measuring Risk051015Number of SecuritiesPortfolio standard deviation7- 13McGraw Hill/IrwinCopyright 2003 by The McGraw-Hi

12、ll Companies, Inc. All rights reserved Measuring Risk051015Number of SecuritiesPortfolio standard deviationMarket riskUniquerisk7- 14McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Portfolio Risk2222211221122121122112212121xxx xx2Stock xx xxx1Stock 2Stock 1Stoc

13、k The variance of a two stock portfolio is the sum of these four boxes7- 15McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Portfolio RiskExample Suppose you invest 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10

14、% x 65% = 6.5% and on Reebok it is 20% x 35% = 7.0%. The expected return on your portfolio is 6.5 + 7.0 = 13.50%. Assume a correlation coefficient of 1.7- 16McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Portfolio Risk222222211221211221222121)5 .58()35(.x5 .58

15、5 .311 35.65.xxReebok5 .585 .311 35.65.xx)5 .31()65(.xCola-CocaReebokCola-CocaExample Suppose you invest 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10% x 65% = 6.5% and on Reebok it is 20% x 35% = 7.0%. The expected return on your portfolio is 6.5

16、+ 7.0 = 13.50%. Assume a correlation coefficient of 1.7- 17McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Portfolio RiskExample Suppose you invest 65% of your portfolio in Coca-Cola and 35% in Reebok. The expected dollar return on your CC is 10% x 65% = 6.5% a

17、nd on Reebok it is 20% x 35% = 7.0%. The expected return on your portfolio is 6.5 + 7.0 = 13.50%. Assume a correlation coefficient of 1.% 31.7 1,006.1 Deviation Standard1 .006, 15)1x31.5x58.2(.65x.35x x(58.5)(.35) x(31.5)(.65) Valriance Portfolio22227- 18McGraw Hill/IrwinCopyright 2003 by The McGraw

18、-Hill Companies, Inc. All rights reserved Portfolio Risk)rx()r(x Return PortfolioExpected2211)xx(2xxVariance Portfolio211221222221217- 19McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Portfolio RiskThe shaded boxes contain variance terms; the remainder contain

19、 covariance terms.123456N123456NSTOCKSTOCKTo calculate portfolio variance add up the boxes7- 20McGraw Hill/IrwinCopyright 2003 by The McGraw-Hill Companies, Inc. All rights reserved Beta and Unique RiskbetaExpectedreturnExpectedmarketreturn10%10%-+-10%+10%stockCopyright 1996 by The McGraw-Hill Companies, Inc-10%1. Total risk = diversifiable risk + market risk2. Market risk is measured by beta, the sensitivity to ma