Professional Documents
Culture Documents
3-ch05 and 06
3-ch05 and 06
Lecture 3
1-1
7-1
FIN204
Chapter 5
5-2
Brokerage Operations
5-3
Account Types
5-4
Fees and Costs
5-5
Transaction Charges in Malaysia
Commission
Clearing Fees
Stamp Duty
Calculation of Purchased Contract
Total = 6,302.63
Calculation of Contract Value - Example
Total = 15,370.85
Orders in Auction Markets
5-16
Types of Orders
5-17
Settlement
5-18
Self-Regulation
5-19
Margin Accounts
A brokerage account in which the broker lends
the customer cash to purchase securities.
The loan in the account is collateralized by the
securities purchased and cash in the account.
Investor usually pays part of investment cost,
borrows remainder from broker
The broker charges the investor interest for the
right to borrow money
5-20
Margin Accounts
Margin is percent of total investment that cannot
be borrowed from broker
Federal Reserve sets the minimum initial margin
on securities (Unchanged since 1974 at 50%)
Actual margin at any time cannot go below the
maintenance margin level set by exchanges,
brokers
Investors equity changes with price
Margin call when equity below maintenance level
5-21
Short Selling
Investor borrows stock from broker
Borrowed security sold in open market,
to be repurchased later at an expected
price lower than sale price
Investor liable for declared dividends
Short sale proceeds held by broker
Only regulated short selling is allowed
in Malaysia
Not easily available for retailer
5-22
Chapter 6
6-23
Asset Valuation
6-24
Return Components
6-26
Risk Types
6-27
Measuring Returns Total Returns
For comparing performance over time or
across different securities
Total Return is a percentage relating all cash
flows received during a given time period, to
price at the start of period:
Where:
CFt = Cash flow during period t such as dividend
PE = Price at end of period
PB = Price at beginning of period
6-28
Example: Measuring Total Return
Assume that you purchased 100 shares at $30 at the
beginning of the year and sold them at the end of
year at $26 and you received a dividend of $2 during
the year.
TR = [2 + (26 30)] / 30
= 2 + (-4)/30
= - 0.0667
= - 6.67%
1-29
Measuring Returns
Total Return can be either positive or
negative
When cumulating or compounding, negative
returns are problem
A Return Relative solves the problem because
it is always positive
6-30
Example: Measuring Relative Return
RR = (2 + 26) / 30
= 0.933
Notes: In other words: RR = 1 + TR
1 + (-0.0667) = 0.9333
1-31
Measuring Returns Wealth Index
6-32
Example: Measuring Wealth Index
Calculate the cumulative wealth per $1 invested in the
beginning of 1990 for a 10-year period using return of
S&P 500 as per Table 6-1 in the text book
1-33
Measures Describing a Return Series
6-34
Geometric Mean
6-35
Historical Rates of Return
Example: Assume that you invest $200 at the
beginning of the year and get back $220 at the end
of the year. What are the HPR and the HPY for your
investment?
1-36
Historical Rates of Return
Computing Mean Historical Returns
Suppose you have a set of annual rates of return
for an investment. How do you measure the mean
annual return?
Arithmetic Mean Return (AM)
AM= X / n
where X=the sum of all the annual returns
n=number of years
Geometric Mean Return (GM)
GM= [ X] 1/n -1
where HPR=the product of all the annual HPRs; OR
1-37
Historical Rates of Return
Suppose you invested $100 three years ago and it is
worth $110.40 today. The information below shows
the annual ending values and RR. This example
illustrates the computation of the AM and the GM
over a three-year period for an investment.
1-38
Comparison of AM and GM
AM ={[(1.15)+(1.20)+(0.80)] / 3} - 1
= (3.15/3) - 1
= 1.05 -1
= 0.05
= 5%
1-39
Arithmetic Versus Geometric
Arithmetic mean does not measure the compound
growth rate over time
Does not capture the realized change in wealth over
multiple periods
Does capture typical return in a single period
6-40
Expected Rates of Return
In previous examples, we discussed realized
historical rates of return. In contrast, an
investor would be more interested in the
expected return on a future risky investment.
Risk refers to the uncertainty of the future
outcomes of an investment
There are many possible returns/outcomes from an
investment due to the uncertainty
Probability is the likelihood of an outcome
The sum of the probabilities of all the possible
outcomes is equal to 1.0.
1-41
Measuring Risk
6-42
Expected Rates of Return
Computing Expected Rate of Return
1-43
Probability Distributions
Risk-free Investment
1-44
Expected Rates of Return
Computing Expected Rate of Return
= 1 X 0.05
= 0.05
= 5%
1-45
Probability Distributions
Risky Investment with 3 Possible Returns
1-46
Expected Rates of Return
Computing Expected Rate of Return
1-47
Probability Distributions
Risky investment with ten possible returns
1-48
Expected Rates of Return
Computing Expected Rate of Return
1-49
Risk of Expected Return
Risk refers to the uncertainty of an
investment; therefore the measure of risk
should reflect the degree of the uncertainty.
The risk of expected return reflect the degree
of uncertainty that actual return will be
different from the expect return.
The common measures of risk are based on
the variance of rates of return distribution of
an investment.
1-50
Risk of Expected Return
1-51
Risk of Expected Return
1-52
Risk of Expected Return
Variance for the 2nd Example:
1-53
Risk of Expected Return
Standard Deviation (): It is the square root
of the variance and measures the total risk
1-54
Risk of Expected Return
Standard Deviation for the 2nd Example:
Variance = 0.0141
Standard Deviation = Square Root of Variance
Standard Deviation
= Square Root of 0.0141
= 0.1187
= 11.874%
1-55
Risk of Expected Return
Coefficient of Variation (CV) for the 2 nd
Example:
CV
= 0.1187 / 0.07
= 1.696
1-56
Risk of Expected Return
Investment A Investment B
Expected Return 0.07 0.12
Standard Deviation 0.05 0.07
Coefficient of Variation 0.714 0.583
1-57
Risk Premiums
6-58
The Risk-Return Record
6-59
The End
2-60
Tutorial Questions
Chapter 5
Questions: 1, 3, 6, 23
Problems: 2
Chapter 6
Questions: 1, 5, 6, 8,10, 14
Problems: 1, 2, 3
2-61