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    Investment Management

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    Investment Management

    Uploaded by

    clarkbuenavides
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    Holla

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    investment Management

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    7 views4 pages

    Investment Management

    Uploaded by

    clarkbuenavides
    Holla

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 4

    Investment Risk and Returns

    1. Introduction to Risk and Return


     Risk: The uncertainty about returns. It involves both danger and opportunity.
     Return: The gain or loss on an investment over a specified period.

    2. Types of Risk
     Systematic Risk: Market risk that cannot be diversified away (e.g., economic changes, political
    events).
     Unsystematic Risk: Specific to a company or industry and can be reduced through
    diversification (e.g., company management, financial practices).

    3. Measuring Risk
     Variance: Measures the dispersion of returns around the mean.
     Standard Deviation: The square root of variance, indicating the average deviation from the
    mean.
     Beta: Measures a stock’s volatility relative to the market.

    4. Risk-Return Tradeoff
     Higher risk is associated with the potential for higher returns.
     Investors demand a risk premium for taking on additional risk.

    5. Calculating Returns
     Realized Return: The actual gain or loss experienced.
    o Example: Buying a stock at $95 and selling at $200 results in a cash return of $1051.
     Expected Return: The anticipated return based on probabilities of different outcomes.

    6. Historical Patterns
     Riskier investments like stocks have historically provided higher returns compared to safer
    investments like bonds1.

    7. Efficient Market Hypothesis


     Asserts that stock prices reflect all available information.
     Implications for investors: It is difficult to consistently achieve higher returns than the overall
    market.

    8. Practical Applications
     Portfolio Diversification: Reduces unsystematic risk by investing in a variety of assets.
     Asset Allocation: Balancing risk and return by distributing investments across different asset
    classes.

    9. Conclusion
     Understanding the relationship between risk and return is crucial for making informed
    investment decisions.
     Proper measurement and management of risk can enhance investment performance.

    The Capital Asset Pricing Model (CAPM) is a financial model used to determine the expected return
    on an investment, given its risk. It establishes a linear relationship between the required return on an
    asset and its systematic risk (market risk). The formula for CAPM is:
    ER_i = R_f + \beta_i (ER_m - R_f)
    where:
     ( ER_i ) = Expected return of the investment
     ( R_f ) = Risk-free rate (typically the Treasury bill rate)
     ( \beta_i ) = Beta of the investment (a measure of its volatility relative to the market)
     ( ER_m ) = Expected return of the market
     ( ER_m - R_f ) = Market risk premium
    CAPM helps investors understand the relationship between risk and return, allowing them to assess
    whether an investment is fairly valued based on its risk and the time value of money123.

    For further reading:


    Read Chapter 4 of Financial Management Book by Bagayao and Manalo
    Security Market Line (SML)
    The Security Market Line (SML) is a graphical representation of the Capital Asset Pricing Model
    (CAPM). It illustrates the relationship between the expected return of a security and its systematic risk
    (beta). Here are the key points:
     Axes:
    o X-axis: Represents the beta (systematic risk) of the security.
    o Y-axis: Represents the expected return.
     Formula:
    \text{Expected Return} = \text{Risk-Free Rate} + \beta (\text{Market Return} - \text{Risk-Free
    Rate})
     Interpretation:
    o Above the SML: Securities are considered undervalued as they offer higher returns for
    their risk level.
    o On the SML: Securities are fairly valued.
    o Below the SML: Securities are overvalued as they offer lower returns for their risk
    level.
     Usage:
    o Helps investors determine if a security offers a favorable expected return compared to
    its risk.
    o Assists in comparing different securities to decide which ones to include in a portfolio12.
    The SML is a valuable tool for evaluating investments, but it should be used alongside other methods
    for a comprehensive analysis.

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