Accountin Chapter 8.docVIP

CHAPTER 5 Risk and Return INSTRUCTOR’S RESOURCES Overview This chapter focuses on the fundamentals of the risk and return relationship of assets and their valuation. For the single asset held in isolation, risk is measured with the probability distribution and its associated statistics: the mean, the standard deviation, and the coefficient of variation. The concept of diversification is examined by measuring the risk of a portfolio of assets that are perfectly positively correlated, perfectly negatively correlated, and those that are uncorrelated. Next, the chapter looks at international diversification and its effect on risk. The Capital Asset Pricing Model (CAPM) is then presented as a valuation tool for securities and as a general explanation of the risk-return trade-off involved in all types of financial transactions. PMF DISK This chapters topics are not covered on the PMF Tutor or PMF Problem-Solver. PMF Templates Spreadsheet templates are provided for the following problems: Problem Topic Self-Test 1 Portfolio analysis Self-Test 2 Beta and CAPM Problem 5-7 Coefficient of variation Problem 5-26 Security market line, SML Study Guide The following Study Guide examples are suggested for classroom presentation: Example Topic 4 Risk attitudes 6 Graphic determination of beta 12 Impact of market changes on return ANSWERS TO REVIEW QUESTIONS 5-1 Risk is defined as the chance of financial loss, as measured by the variability of expected returns associated with a given asset. A decision maker should evaluate an investment by measuring the chance of loss, or risk, and comparing the expected risk to the expected return. Some assets are considered risk-free; the most common examples are U. S. Treasury issues. 5-2 The return on an investment (total gain or loss) is the change in value plus any cash distributions over a defined time period. It is expressed as a percent of the beginning-of-the-period investment. The for