Copyright 2008 The McGraw-Hill Companies 14W-1 Financial Investment Applications Risk The Security...
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Copyright 2008 The McGraw-Hill Companies 14W-1 Financial Investment Applicatio ns Risk The Securi ty Market Line Last Word Key Terms End Show 14 Financial Economics WEB
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Transcript of Copyright 2008 The McGraw-Hill Companies 14W-1 Financial Investment Applications Risk The Security...
Copyright 2008 The McGraw-Hill Companies14W-1
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
14Financial Economics
WEB
Copyright 2008 The McGraw-Hill Companies14W-2
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
Chapter Objectives• The Idea of Present Value
and Why it is Critical in Making Financial Decisions
• About the Most Popular Investments: Stocks, Bonds, and Mutual Funds
• How Investment Returns Compensate for Being Patient and for Bearing Risk
Copyright 2008 The McGraw-Hill Companies14W-3
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
Chapter Objectives• About Portfolio Diversification
and Why It Implies that Investors Can Focus on Nondiversifiable Risk When Evaluating an Investment Opportunity
• Why Higher Levels of Nondiversifiable Risk Are Associated With Higher Rates of Return
• Why Even Professionals Have a Hard Time Trying to “Beat the Market”
Copyright 2008 The McGraw-Hill Companies14W-4
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
Financial Investment• Economic Investment• Financial Investment• Present Value
–Compound Interest–The Present Value Model
Dollars Today = X Dollars in t YearsX
( 1 + i)t
W 14W.1
Copyright 2008 The McGraw-Hill Companies14W-5
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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Applications• Take the Money and Run• Salary Caps and Deferred
Compensation• Some Popular Investments
–Stocks–Bankrupt–Limited Liability Rule–Capital Gains–Dividends
Copyright 2008 The McGraw-Hill Companies14W-6
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
Applications• Bonds
– Default• Mutual Fund
– Portfolio– Index Funds– Actively Managed Funds– Passively Managed Funds
• Calculating Investment Returns– Percentage Rate of Return
• Asset Prices and Rates of Return
• Arbitrage
Copyright 2008 The McGraw-Hill Companies14W-7
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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Risk• Diversification• Diversifiable Risk• Nondiversifiable Risk• Comparing Risky
Investments• Average Expected Rate of
Return• Probability Weighted
Average• Beta
–Market Portfolio
O 14W.1
Copyright 2008 The McGraw-Hill Companies14W-8
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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Risk• Relationship of Risk
and Average Expected Rates of Return
• The Risk-Free Rate of Return
• Time Preference• Risk-Free Interest
Rate• Risk Premium
Copyright 2008 The McGraw-Hill Companies14W-9
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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RiskGLOBAL PERSPECTIVE
Investment Risks Across Different Countries
NorwayLuxembourgSwitzerland
JapanChile
United StatesChina
MexicoIndia
GhanaIndonesia
NigeriaSomalia
ZimbabweIraq
0 20 40 60 80 100
Source: International Country Risk Guide
Copyright 2008 The McGraw-Hill Companies14W-10
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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The Security Market LineAverage Expected
Rate of Return=
Rate That Compensates
For Time Preference
+Rate That
CompensatesFor Risk
Security MarketLineMarket
Portfolio
Risk-FreeInterest Rate, if
AverageExpectedRate ofReturn
Risk Level (beta)0 1.0
CompensationFor Time-PreferenceEquals if
Risk Premium forThe Market Portfolio’sRisk Level of beta=1.0
A Risk-free Asset(i.e., a short-term U.S.Government bond)
Copyright 2008 The McGraw-Hill Companies14W-11
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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The Security Market Line
Security MarketLine
if
AverageExpectedRate ofReturn
Risk Level (beta)0 X
CompensationFor Time-PreferenceEquals if
Risk Premium forThis Asset’s RiskLevel of beta = X
Risk Levels Determine Average Expected Rates of Return
Y
Copyright 2008 The McGraw-Hill Companies14W-12
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
The Security Market Line
Security MarketLine
AverageExpectedRate ofReturn
Risk Level (beta)0 X
Arbitrage and the Security Market
Y
A
B
C
Copyright 2008 The McGraw-Hill Companies14W-13
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
The Security Market Line
SML 1
AverageExpectedRate ofReturn
Risk Level (beta)0 X
An Increase in the Risk-Free Rate
Y2
A Before Increase
A After Increase
SML 2
Y1
Copyright 2008 The McGraw-Hill Companies14W-14
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
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Why Do Index Funds Beat Actively Managed Funds
• Choice of Actively or Passively Managed Mutual Funds
• After Costs, Index Funds Outperform Actively Managed by 1% Per Year
• Management Costs Are Significant
• Index Funds May Pay More But Actively Managed Offer a More Exciting Opportunity to “Play” in the Market
Last
Word
Copyright 2008 The McGraw-Hill Companies14W-15
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
Key Terms• economic investment• financial investment• compound interest• present value• stocks• bankrupt• limited liability rule• capital gains• dividends• bonds• default• mutual funds• portfolios• index funds• actively managed fund
s• passively managed fu
nds
• percentage rate of return
• arbitrage• risk• diversification• diversifiable risk• nondiversifiable risk• average expected rate
of return• probability weighted av
erage• beta• market portfolio• time preference• risk-free interest rate• Security Market Line• risk premium
Copyright 2008 The McGraw-Hill Companies14W-16
Financial InvestmentApplicationsRiskThe Security Market LineLast Word
Key Terms
End Show
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Extending the Analysis Of Aggregate Supply
