Mpt lec 2
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This document provides a summary of a lecture on modern portfolio theory. It discusses various financial securities including money market instruments, fixed income securities, equity instruments, and derivative instruments. It also covers common measures of risk and return such as probability distributions, expected return, variance, standard deviation, and historical returns. Examples are provided to illustrate how to calculate expected return, variance, standard deviation, and historical returns for stocks. The lecture includes a quiz and documentary.
Mpt lec 2
- 1. Modern Portfolio Theory MS Lecture # 1: Introduction Lecturer: Muhammad Usman
- 2. Today’s Lecture Measures of Risk & Return Financial Securities Quiz Documentary!!
- 3. Financial Securities Financial Assets Direct Investing Indirect Investing (e.g. Mutual funds) Money Market Instruments Fixed Income Instruments Capital Market Instruments Equity Instruments Derivative Instruments
- 4. Money Market Securities Short term Debt Instruments with maturities, when issued for a year or less Low Risk Sold by governments, Financial institutions & Corporations Some are not actively traded on exchanges
- 5. Major Money Market Instruments Treasury Bills Repurchase Agreement LIBOR Commercial Paper
- 6. Capital Market Securities Instruments with longer or no maturity Fixed Income Securities Specified Payment Schedule. Mostly traditional bonds Pay specific amounts at specific time Equity Market
- 7. Fixed Income Securities Treasury Notes Treasury bonds 1 than 10 year maturity More than 10 year maturity Federal Agency Securities Corporate bonds
- 8. Common Stock(Equity) Ownership of assts & earning of corporation After debt claims, earnings can be reinvested or paid as dividend Holder has limited liability
- 9. Derivative Instruments Securities whose value derives from the value of an underlying security or basket of securities Option Right to buy(Call) or (Sell) Future A delayed Purchase of security
- 10. Common Measures of Risk and Return Probability Distributions –When an investment is risky, there are different returns it may earn. Each possible return has some likelihood of occurring. This information is summarized with a probability distribution, which assigns a probability, PR , that each possible return, R , will occur.
- 11. Example: Probability Distributions Assume stock A currently trades for $100 per share. In one year, there is a 25% chance the share price will be $140, a 50% chance it will be $110, and a 25% chance it will be $80.
- 13. Expected Return Expected (Mean) Return – Calculated as a weighted average of the possible returns, where the weights correspond to the probabilities.
- 14. Variance and Standard Deviation Variance – The expected squared deviation from the mean Standard Deviation – The square root of the variance Both are measures of the risk of a probability distribution
- 15. Variance and Standard Deviation For Stock A, the variance and standard deviation are In finance, the standard deviation of a return is also referred to as its volatility. The standard deviation is easier to interpret because it is in the same units as the returns themselves
- 16. Example
- 17. Solution
- 18. Example Stock B has the following probability distribution:
- 19. Solution
- 20. Historical Returns of Stocks and Bonds Computing Historical Returns –Realized Return The return that actually occurs over a particular time period. =Dividend Yield + Capital Gain Rate
- 21. Historical Returns of Stocks and Bonds Computing Historical Returns If a stock pays dividends at the end of each quarter, with realized returns RQ1, . . . ,RQ4 each quarter, then its annual realized return, R annual, is computed as
- 22. Example
- 23. Solution
- 24. Another Example What were the realized annual returns for Ford stock in 1999 and in 2008?
- 25. Solution
- 26. Solution
- 28. Table 10.2
- 29. The Variance and Volatility of Returns
- 30. Example
- 31. Solution
- 32. Another Example Using the data from Table 10.2, what are the variance and volatility of GM’s returns from 1999 to 2008?
- 33. Solution
- 34. Solution
- 35. Thank you!