3353 Risk Return
MPU 3353
Personal Financial
Planning in Malaysia
Investment Basics:
Understanding Risk and
Return
10-1
Introduction
Risk is a fundamental component of investing. Risk must be understood and managed.
In selecting securities, it is important to understand and measure market risk.
Then securities can be selected by choosing securities with expected returns that exceed required returns.
10-2
Chapter Objectives
To grasp the nature of risk and its sources and to relate risk to investment return
To grasp the concepts of required return and expected return and to see how they are used in security selection
To become familiar with important methods and issues involved in establishing a portfolio and making changes over time
10-3
Topic Outline
Risk
Return
Applying a Risk-Return Model (Capital
Asset Pricing Model - CAPM)
10-4
Risk and Return
What is Risk?
Sources of Risk
How Much Return Do You Need?
The Iron Law of Risk and Return
(CAPM)
To earn higher returns, you must take greater risks.
There is a strong positive correlation between higher investment return and greater risk.
10-5
What Is Risk?
Investment risk is defined as the more variable an investment’s return, the greater its risk.
The more uncertainty associated with the expected outcome, the greater the risk of the investment.
A highly variable return could lead to investment losses if the investment must be sold.
The longer the time period before an investment pays off, the greater the risk.
Investors with long investment
10-6
Sources of Risk
There are two basic sources of risk:
Changing Economic Conditions
Changing Conditions of the Issuer
10-7
Changing Economic
Conditions
Inflation risk: Will your investment returns keep pace with inflation? If not, your return may be insufficient.
Business cycle risk: Your investment return fluctuates in concert with the overall business cycle.
Interest rate risk: Bond prices fluctuate as interest
Personal Financial
Planning in Malaysia
Investment Basics:
Understanding Risk and
Return
10-1
Introduction
Risk is a fundamental component of investing. Risk must be understood and managed.
In selecting securities, it is important to understand and measure market risk.
Then securities can be selected by choosing securities with expected returns that exceed required returns.
10-2
Chapter Objectives
To grasp the nature of risk and its sources and to relate risk to investment return
To grasp the concepts of required return and expected return and to see how they are used in security selection
To become familiar with important methods and issues involved in establishing a portfolio and making changes over time
10-3
Topic Outline
Risk
Return
Applying a Risk-Return Model (Capital
Asset Pricing Model - CAPM)
10-4
Risk and Return
What is Risk?
Sources of Risk
How Much Return Do You Need?
The Iron Law of Risk and Return
(CAPM)
To earn higher returns, you must take greater risks.
There is a strong positive correlation between higher investment return and greater risk.
10-5
What Is Risk?
Investment risk is defined as the more variable an investment’s return, the greater its risk.
The more uncertainty associated with the expected outcome, the greater the risk of the investment.
A highly variable return could lead to investment losses if the investment must be sold.
The longer the time period before an investment pays off, the greater the risk.
Investors with long investment
10-6
Sources of Risk
There are two basic sources of risk:
Changing Economic Conditions
Changing Conditions of the Issuer
10-7
Changing Economic
Conditions
Inflation risk: Will your investment returns keep pace with inflation? If not, your return may be insufficient.
Business cycle risk: Your investment return fluctuates in concert with the overall business cycle.
Interest rate risk: Bond prices fluctuate as interest