Investment Analysis and Portfolio Management Investment A curr ent commitment of funds for a period of ti me in order to derive future payments that will compensate for: ● the time the funds a re committed ● the expected rate of inflation ● uncertainty of future flow of funds.
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 1/55
Investment Analysis and
Portfolio Management
Investment
A current commitment of funds for a period of time in order to derive future
payments that will compensate for:
●the time the funds are committed
●the expected rate of inflation
●uncertainty of future flow of funds.
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 2/55
Investment Analysis and
Portfolio Management
Nonmarketable Financial Assets
Savings accounts , Certificates of Deposit like National
$he Ereek letter pi stands for product summation $his means that instead of
adding values in the series, they are multiplied $he rest of the e"uation indicates
that after multiplying the return, we take the nth root of the product, where n is the
number of terms in the series
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 23/55
Investment Analysis and
Portfolio Management
Calculating the geometric means of a series of a return has a potential problem
because returns are often negative 'f the number of negative returns in a series is
odd, there product will be negative and negative number does not have an even
root
't is easy to eliminate the problem by converting security returns into returnrelatives before calculating the statistics on them
A return relative is simply the return plus 4
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 24/55
Investment Analysis and
Portfolio Management
During the past five years, you owned two stocks that had the following
annual rates of return:
/ear tock 0 tock 14 549 55>
55> 557
7 B54 B559
8 B557 55
; 54; 558
Compute the geometric mean annual rate of return for each stock
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 25/55
Investment Analysis and
Portfolio Management
E#$ ? F04491 045>1 0>>1 09G1 044;1H4I; %4
? F4=4=5H 4I; B4 ? 458G;G B4 ? 58G;G
E#& ? F045>1 04571 0941 0451 04581H4I;
%4
? F45G7>7H 4I; B4 ? 45487; B 4 ? 5487;
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 26/55
Investment Analysis and
Portfolio Management
During the past five years, you owned two stocks that had the following
annual rates of return:
/ear tock 0 tock 14 549 55>
55> 557
7 B54 B559
8 B557 55
; 54; 558
Compute the arithmetic mean annual rate of return for each stock .hich stock
is most desirable by this measureJ
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 27/55
Investment Analysis and
Portfolio Management
$toc% & is 'ore (esirable beca#se the arith'etic 'ean ann#al rate o) ret#rn
is higher.
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 28/55
Investment Analysis and
Portfolio Management
"xpected &ates of &eturn
● Risk is uncertainty that an investment will earn its
epected rate of return
● *robability is the likelihood of an outcome
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 29/55
Investment Analysis and
Portfolio Management
"xpected &ates of &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 30/55
Investment Analysis and
Portfolio Management
S/ *robability *ossible Return
&# ;5 G5
Recession ;5 %5
"xpected &ates of &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 31/55
Investment Analysis and
Portfolio Management
S/ *robability *ossibleReturn
/pected Return
&# 5;5 5G5 57;
Recession 5;5 %55 %545
5;
"xpected &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 32/55
Investment Analysis and
Portfolio Management
State of /conomy *robability *ossible Return
&oom ; 45
Recession ; 7
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 33/55
Investment Analysis and
Portfolio Management
Considering the world economic outlook for the coming year and estimates of salesand earnings for the pharmaceutical industry, you epect the rate of return for Kauren
Kabs common stock to range between B5 percent and @85 percent with the following
probabilities:
Probability Possible &eturns
54 B55
54; B55;
5 545; 54;
5 5
54 58
Compute the epected rate of return F E 0 Ri1H for Kauren Kabs
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 34/55
Investment Analysis and
Portfolio Management
● &isk Free &ate of &eturn 2&F&3
● Market &ate of &eturn 2M&3
● &e#uired &ate of &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 35/55
Investment Analysis and
Portfolio Management
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 36/55
Investment Analysis and
Portfolio Management
State of /conomy *robability Possible &eturn
Stock A Stock & Stock C
&oom 85 45 4; 5
Recession =5 5> 58 5
Portfolio &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 37/55
Investment Analysis and
Portfolio Management
State of /conomy *robability Poss
ible &eturn
Stock A Stock & Stock C
&oom 85 45 4; 5
Recession =5 5> 58 5
'nvestment Criteria
;5 'nvestment in Stock A
; 'nvestment in Stock &
; 'nvestment in Stock C
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 38/55
Investment Analysis and
Portfolio Management
"xpected Portfolio &eturn
&oom ;5L 45 @;L4;@;L5
5;@57G;@5; ?47G;
Recession ;5L5>@;L58@;L5 ? 5;
State of /conomy *robability &eturn
Stock A Stock & Stock C
&oom 85 45 4; 5
Recession =5 5> 58 5
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 39/55
Investment Analysis and
Portfolio Management
Probabilit* *ortfolio Return
&oom 85 47G;
Recession =5 5;
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 40/55
Investment Analysis and
Portfolio Management
/pected Return of 'ndividual Stock Stock A
&oom 85L45 ? 58
Recession =5L5> 58>
5>>
Stock &
85L4; ?5==5L58 ?58
5>8
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 41/55
Investment Analysis and
Portfolio Management
tock !85L5 ?5>
=5L5 ?55
?5>
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 42/55
Investment Analysis and
Portfolio Management
"xpected &eturn of Portfolio1ased on Investment !riteria
;5L5>> ? 588
;L5>8 ? 54
;L5> ? 5
? 5>;
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 43/55
Investment Analysis and
Portfolio Management
Probabilit* *ortfolio Return AverageReturn
&oom 85 47G; 5>;
Recession =5 5; 5>;
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 44/55
Investment Analysis and
Portfolio Management
Annuali-ed Rate of Return ? Average #onthly Return L 4
Annuali4ed &ate of &eturn
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 45/55
Investment Analysis and
Portfolio Management
Possible &ate of &eturn Probability
B545 57
5 54
54 575; 57
<ou are considering ac"uiring shares of common stock in the #adison &eerCorporation <our rate of return epectations are as follows:
Compute the epected return F E 0 Ri1H on your investment in #adison &eer
During the past year, you had a portfolio that contained !S government $%bills,long%term government bonds, and common stocks $he rates of return on each of
them were as follows:
During the year, the consumer price inde, which measures the rate of inflation, went
from 4=5 to 4G 049>B49>8 ? 4551 Compute the rate of inflation during this yearCompute the real rates of return on each of the investments in your portfolio based on
the inflation rate
A i
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 48/55
Investment Analysis and
Portfolio Management
I A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 49/55
Investment Analysis and
Portfolio Management
Assume that the consensus re"uired rate of return on common stocks is 48 percent 'n
addition, you read in Fortune that the epected rate of inflation is ; percent and the
estimated long%term real growth rate of the economy is 7 percent .hat interest rate
would you epect on !S government $%billsJ .hat is the approimate risk premium forcommon stocks implied by these data
I A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 50/55
Investment Analysis and
Portfolio Management
Nominal rate on $%bills 0or risk%free rate1
? 04 @ 571 04 @ 5;1 B 4
?45>4; B 4 ? 5>4; or >4;
$he re"uired rate of return on common stock is e"ual to the risk%free rate plus a risk
premium $herefore the approimate risk premium for common stocks implied by
these data is:
? 48 % 5>4; ? 5;>; or ;>;
I t t A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 51/55
Investment Analysis and
Portfolio Management
$he following are annual rates of return for !S government $%bills and !M
common stocks
Year
5.. 6overnment071ills
5.8. !ommontock
557 55=7 54;5
558 55>4 5587
55; 55G= 57G8
55= 5595 549
55G 55>; 545=
Compute the arithmetic mean rate of return and discuss these two alternative
investments in terms of their arithmetic average rates of return
I t t A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 52/55
Investment Analysis and
Portfolio Management
0b1 $he average return of !S Eovernment $%&ills is lower than the average return
of !nited Mingdom Common Stocks because !S Eovernment $%&ills are riskless,
therefore their risk premium would e"ual 5 $he !M Common Stocks are subect to
the following types of risk: business risk, financial risk, li"uidity risk, echange rate
risk, 0and to a limited etent1 country risk
I t t A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 53/55
Investment Analysis and
Portfolio Management
<ou read in Business Recorder that a panel of economists has estimated that the long%
run real growth rate of the *ak economy over the net five%year period will average 7
percent 'n addition, a bank newsletter estimates that the average annual rate of inflation
during this five%year period will be about 8 percent .hat nominal rate of return would
you epect on *ak government $%bills during this periodJ
NR(R ? 04 @ 571 04 @ 581 B 4 ? 45G4 B 4 ? 5G4
I t t A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 54/55
Investment Analysis and
Portfolio Management
The Wall Street Journal reported that the yield on common stocks is about percent,
whereas a study at the !niversity of Chicago contends that the annual rate of return on
common stocks since 49= has averaged about 4 percent Reconcile these statements
I t t A l i d
8/9/2019 Lecture 1s
http://slidepdf.com/reader/full/lecture-1s 55/55
Investment Analysis and
Portfolio Management
$he difference is because of the definition and measurement of return 'n the case of
the WSJ , they are only referring to the current dividend yield on common stocks
versus the promised yield on bonds 'n the !niversity of Chicago studies, they are
talking about the total rate of return on common stocks, which is the dividend yield
plus the capital gain or loss yield during the period 'n the long run, the dividendyield has been 8%; percent and the capital gain yield has averaged about the same
$herefore, it is important to compare alternative investments based upon total return