Finance & Contemporary China
Transcript of Finance & Contemporary China
![Page 2: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/2.jpg)
RETURNSection 1:
Kun Li, Finance & Contemporary China 2
![Page 3: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/3.jpg)
• Motivation of investments. • Earning on an investment.
– Income flow– Capital gains
Kun Li, Finance & Contemporary China 3
Return
Income
• Savings
Capital gains
• Land• Real
estates
Both
• Stock• Bond
![Page 4: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/4.jpg)
ReturnExpected return• Anticipate to receive from an investment.
Required return • Necessary to induce an individual to make an
investment and bear the risk.
Realized return• Actually earned.
Kun Li, Finance & Contemporary China 4
![Page 5: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/5.jpg)
• Required return: return necessary to induce an investment (and bear the risk).– Risk-free return– Premium for risk
• Realized return: return actually earned.– Comparable to the expected return– An examination of forecasting
Kun Li, Finance & Contemporary China 5
Return
![Page 6: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/6.jpg)
Expected Return• Expected return depends on
1. Individual expected outcomes2. Probability of occurrence
• Example: an investment with three cases• 20% for a good economic condition, to earn
10% return;• 60% for a normal economic condition, to earn
5% return;• 20% for a bad economic condition, to earn zero
return.Kun Li, Finance & Contemporary China 6
![Page 7: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/7.jpg)
Expected Return
The expected return10% × 20% + 5% × 60% + 0 × 20% = 5%
Kun Li, Finance & Contemporary China 7
Economy Probability ReturnGood 20% 10%
Normal 60% 5%Poor 20% 0
![Page 8: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/8.jpg)
Expected Return
Individual return
Probability
Expected return
Kun Li, Finance & Contemporary China 8
![Page 9: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/9.jpg)
Expected ReturnRevise individual returns
The expected return10% × 20% + 0 × 60% + (−5%) × 20% = 1%
Kun Li, Finance & Contemporary China 9
Economy Probability ReturnGood 20% 10%
Normal 60% 0Poor 20% -5%
![Page 10: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/10.jpg)
Expected ReturnRevise probabilities
The expected return10% × 30% + 5% × 30% + 0 × 40% = 4.5%
Kun Li, Finance & Contemporary China 10
Economy Probability ReturnGood 30% 10%
Normal 30% 5%Poor 40% 0
![Page 11: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/11.jpg)
RISKSection 2:
Kun Li, Finance & Contemporary China 11
![Page 12: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/12.jpg)
Risk
• Risk: uncertainty associated with earning theexpected return.
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑟𝑟𝑅𝑅𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 ≠ 𝐸𝐸𝑥𝑥𝑥𝑥𝑅𝑅𝑥𝑥𝑟𝑟𝑅𝑅𝑅𝑅 𝑟𝑟𝑅𝑅𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟
• Especially
𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝑟𝑟𝑅𝑅𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟 < 𝐸𝐸𝑥𝑥𝑥𝑥𝑅𝑅𝑥𝑥𝑟𝑟𝑅𝑅𝑅𝑅 𝑟𝑟𝑅𝑅𝑟𝑟𝑟𝑟𝑟𝑟𝑟𝑟
Kun Li, Finance & Contemporary China 12
![Page 13: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/13.jpg)
Risk• Risk can only be expected, but sources of risk can
be identified.
• Sources of risk:– Diversifiable risk (Unsystematic): risk associated with a
particular asset.– Nondiversifiable risk (Systematic): risk not reduced
through the construction of a diversified portfolio.
Kun Li, Finance & Contemporary China 13
![Page 14: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/14.jpg)
Sources of Risk
Kun Li, Finance & Contemporary China 14
Risk
DiversifiableBusiness risk
Financial risk
Nondiversifiable
Market
Interest rate
Reinvestment
Purchasing power
Exchange
Sovereign
![Page 15: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/15.jpg)
Diversifiable risk
• Risk associated with a particular asset.– Business risk: associated with the nature of
a business.– Financial risk: associated with the types of
financing used by the firm.
Kun Li, Finance & Contemporary China 15
![Page 16: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/16.jpg)
Diversifiable risk: example
• Risk in the airline industry.– Business risk: cost of fuel, the capacity of
planes, and changes in demand.– Financial risk: firm financing, bank loans
or security issuing.
Kun Li, Finance & Contemporary China 16
![Page 17: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/17.jpg)
Diversifiable risk: example
• Risk in the automobile industry.– Business risk: technology upgrade, safety
of vehicle driving, marketing of vehicle sale.– Financial risk: ↑ with debts or ↓ with equity
financing.• Financial leverage.
Kun Li, Finance & Contemporary China 17
![Page 18: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/18.jpg)
Diversifiable risk
• Firm-specific: can be reduced viadiversification.
Kun Li, Finance & Contemporary China 18
Portfolio
Loan
BondStock
![Page 19: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/19.jpg)
Sources of Risk
Kun Li, Finance & Contemporary China 19
Risk
DiversifiableBusiness risk
Financial risk
Nondiversifiable
Market
Interest rate
Reinvestment
Purchasing power
Exchange
Sovereign
![Page 20: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/20.jpg)
Nondiversifiable risk• Associated with non-firm-specific factors, not
reduced through diversification.• Market risk: associated with movements in
securities prices.– Individual stock price is related to the whole
market.– Market ↓ individual stock ↓– Market ↑ individual stock ↑
Kun Li, Finance & Contemporary China 20
![Page 21: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/21.jpg)
Nondiversifiable risk• Interest rate risk: associated with changes of
interest rates.– Interest rate is related to security prices and
demand/supply of funds.– Bond market: interest ↑ bond ↓
Kun Li, Finance & Contemporary China 21
Interest
Bond value
![Page 22: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/22.jpg)
Nondiversifiable risk• Reinvestment rate risk: associated with
reinvesting earnings.– Reinvestment earnings may be lower than initial
earnings.
Kun Li, Finance & Contemporary China 22
Investment
• Bond• Stock
Earnings
• Interest• Dividend
Choice
• Consumption• Reinvestment
![Page 23: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/23.jpg)
Nondiversifiable risk• Purchasing power risk: associated with
inflation.– Related to deposits and savings.
Kun Li, Finance & Contemporary China 23
Inflation
Purchasing power
![Page 24: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/24.jpg)
Inflation in China
Kun Li, Finance & Contemporary China 24
![Page 25: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/25.jpg)
Inflation in China
Kun Li, Finance & Contemporary China 25
![Page 26: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/26.jpg)
Nondiversifiable risk• Exchange rate risk: associated with
fluctuations in the prices of foreign currencies.– Critical to international trade.– Losses by currency value changes.
Kun Li, Finance & Contemporary China 26
Foreign currency
$
Home currency
¥
![Page 27: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/27.jpg)
Nondiversifiable risk• Sovereign Risk: associated with a
government defaulting on debt obligations.– 2010, the “PIIGS”.
Kun Li, Finance & Contemporary China 27
![Page 28: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/28.jpg)
MEASURE OF RISKSection 3:
Kun Li, Finance & Contemporary China 28
![Page 29: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/29.jpg)
Measures of Risk
• Risk: not removable– Return compensation for bearing risk.– Reduce impacts from risk sources.
Kun Li, Finance & Contemporary China 29
![Page 30: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/30.jpg)
Measures of Risk• Standard deviation: measure of
dispersion around an average value.– Variability of returns: deviation from the average
return.– A measure of risk in finance.
• Standard deviation ↑ risk ↑
Kun Li, Finance & Contemporary China 30
![Page 31: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/31.jpg)
Standard Deviation
Kun Li, Finance & Contemporary China 31
Year Stock A return Stock B return1 5% 02 10% 15%3 10% 15%4 10% 05 5% 10%
![Page 32: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/32.jpg)
Standard Deviation
Kun Li, Finance & Contemporary China 32
Year Stock A return Stock B return1 5% 02 10% 15%3 10% 15%4 10% 05 5% 10%
Average 8.00% 8.00%
![Page 33: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/33.jpg)
Standard Deviation
1. Subtract the average return from theindividual observations.
2. Square this difference.3. Add these squared differences.4. Divide this sum by the number of
observations less one.5. Take the square root.
Kun Li, Finance & Contemporary China 33
![Page 34: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/34.jpg)
Standard Deviation
Kun Li, Finance & Contemporary China 34
Year Stock A return Stock B return1 5% 02 10% 15%3 10% 15%4 10% 05 5% 10%
Average 8.00% 8.00%Std. Dev. 2.74% 7.58%
![Page 35: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/35.jpg)
Beta Coefficients• A measure of systematic risk
– Measure the volatility of one stock relative to themarket.
Kun Li, Finance & Contemporary China 35
Stock 1
Stock 2
Stock 3
Stock market
![Page 36: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/36.jpg)
Beta Coefficients• Beta ↑ risk ↑
– High beta: “aggressive” stocks;– Low beta: “defensive” stocks.
Kun Li, Finance & Contemporary China 36
![Page 37: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/37.jpg)
Beta Coefficients
• Beta = 1.0, stock's return has samevolatility as the market return;
• Beta > 1.0, stock's return is more volatilethan the market return;
• Beta < 1.0, stock's return is less volatilethan the market return.
Kun Li, Finance & Contemporary China 37
![Page 38: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/38.jpg)
Kun Li, Finance & Contemporary China 38
For risk averseinvestors
For risk lover
![Page 39: Finance & Contemporary China](https://reader033.fdocuments.in/reader033/viewer/2022052609/628da3dc00ef4d3f470767d5/html5/thumbnails/39.jpg)
Summary
1. Return: income & capital gains; expectedreturn, required return & realized return.
2. Risk: “diversifiable” vs “nondiversifiable”.3. Measure of risk: standard deviation vs
beta coefficient.
Kun Li, Finance & Contemporary China 39