FAM Final Presentation
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Transcript of FAM Final Presentation
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Evaluation of risk andreturn
Present by:
Arpi langaliya
Jiten lodhiya
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CONTENT
-Introduction-Portfolio theory-Risk and return-Risk evaluation
-Investment and security-co-relation-Systematic and unsystematic risk- How to measure return?-Expected return-How to measure risk?
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RISK AND RETURN ( Portfoliotheory)
1. A portfolio is abundleor acombination of individual assets
or securities.
2. Portfolio theory provides anormative approach to investors
to make decisions to invest theirwealth in assets or securitiesunder risk .
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RISK EVALUATION
1. Risk of individual assets is measuredby their variance or standarddeviation.
2. We can use variance or standarddeviation to measure the risk of theportfolio of assets as well.
3. The risk of portfolio would be lessthan the risk of individual securities,and that the risk of a security shouldbe judged by its contribution to theportfolio risk.
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CO-RELATION
1. The value of correlation, called thecorrelation coefficient, could be positive,negative or zero.
2. It depends on the sign of covariance
since standard deviations are alwayspositive numbers.3. The correlation coefficient always ranges
between 1.0 and +1.0.4. A correlation coefficient of+1.0 implies a
perfectly positive correlation while a
correlation coefficient of1.0 indicates aperfectly negative correlation.
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INVESTMENT AND SECURITY
1. Investing wealth in more than one
security reduces portfolio risk.
2. Diversification always reduces riskprovided the correlation coefficientis less than 1.
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INVESTMENT OPPRTUNITY
1. The investment or portfolioopportunity set represents allpossible combinations of risk and
return resulting from portfoliosformed by varying proportions ofindividual securities.
2. It presents the investor with therisk-return trade-off.
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SYSTEMETIC RISK
1. Systematic risk arises on account ofthe economy-wide uncertainties andthe tendency of individual securitiesto move together with changes in
the market.2. This part of risk cannot be reduced
through diversification.3. It is also known as market risk.
4. Investors are exposed to marketrisk even when they hold well-diversified portfolios of securities.
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UNSYSTEMETIC RISK
1. Unsystematic risk arises from theunique uncertainties of individualsecurities.
2. It is also called unique risk.
3. These uncertainties arediversifiable if a large numbers ofsecurities are combined to form
well-diversified portfolios.4. Unsystematic risk can be totally
reduced through diversification.
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CAPITAL ASSET PRICING MODEL(CAPM)
1. The capital asset pricing model(CAPM) is a model that provides aframework to determine the required
rate of return on an asset andindicates the relationship betweenreturn and risk of the asset.
2. One can also compare the expected
(estimated) rate of return on anasset with its required rate of returnand determine whether the asset isfairly valued.
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ARBITRAGE PRICING THEORY
(APT)
1. The Arbitrage Pricing Theory (APT)describes the method of bring amispriced asset in line with its
expected price.2. An asset is considered mispriced if its
current price is different from thepredicted price as per the model.
3. The fundamental logic of APT is that
investors always indulge in arbitragewhenever they find differences in thereturns of assets with similar riskcharacteristics.
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return = R =change in asset value + income
initial value
Measuring Return
based on past data, and is known
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Example 1 1 month holding period
buy for 9488, sell for 9528
1 month Return:
9528 - 9488
9488= .0042 = .42%
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Example 2
100 shares TATA,
buy for 62, sell for 101.50
.80 dividends
101.50 - 62 + .80
62= .65 =65%
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Expected Return
Measuring likely future return
based on probability distribution
random variable
E(R) = SUM[Ri x Prob(Ri)]
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Example 1
Return Probability(Return)
10% .25% .4
-5% .4
E(R) = (.2)10% + (.4)5% + (.4)(-5%)
= 2%
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Example 2
Return Probability(R)
1% .32% .4
3% .3
E(R) = (.3)1% + (.4)2% + (.3)3%
= 2%
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Examples 1 & 2
same expected return
returns in example 1 are morevariable
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Risk
Measure likely fluctuation in return
how much will Return vary fromE(Return)
How possible is actual Return tovary from E(Return)
Measured by
variance (s2) standard deviation (s)
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s2 = SUM[(Ri - E(R))2 x Prob(Ri)]
s = s2
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Example 1
s2 = (.2)(10%-2%)2
= .0036
+ (.4)(5%-2%)2
+ (.4)(-5%-2%)2
s = 6%
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Example 2
s2 = (.3)(1%-2%)2
= .006
+ (.4)(2%-2%)2
+ (.3)(3%-2%)2
s = .77%
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Same expected return.
But example 2 has a lower risk
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