FM (Bringing Together Risk and Return)
FM (Bringing Together Risk and Return)
FM (Bringing Together Risk and Return)
NICKO C. NOCEJA
Presenter
RISK & RETURN: YOU CAN'T HAVE ONE WITHOUT THE OTHER
PAIN NO YES
YES NO
GAIN
UNDERSTANDING RETURN
Return is a measure of investment gain or loss.
If you invest at different times, as most people do, you also need to know your
investments' annual percent return to measure one performance against another.
TYPE OF RISK
MARKET RISK - This is the possibility that the financial markets will
drop in value and create a ripple effect in your portfolio.
INTEREST RATE RISK - This is the possibility that interest rates will go
up
SYTEMIC RISK
Risk you can't control
You can build your risk tolerance — or compensate for it — in several ways:
You can build your risk tolerance — or compensate for it — in several ways:
where:
FO=Return on best forgone option
CO=Return on chosen option
Invest excess capital in the stock market to potentially earn capital
A gains.
Assume that the expected ROI in the stock market is 12% over the
12
next year.
% Invest excess capital back into the business for new equipment to
B increase production efficiency.
And your company expects the equipment update to generate a 10%
10% return over the same period.
The opportunity cost of choosing the equipment over the stock market
2% is 2% (12% - 10%)
OPPORTUNITY COST AND RISK
If investment A is risky but has an ROI of 25%, while investment B is far less
risky butStrategy
onlyMarketing
has an ROITarget
of Goals
5%, even Company's
thoughCareer
investment A may
Serve customers
succeed, it
may not. If it fails, then the opportunity cost of going with option B will be
salient.
E T
R K
M A
Market efficiency refers to the degree to which market prices reflect all
available, relevant information. If markets are efficient, then all information is
already incorporated into prices, and so there is no way to "beat" the market
because there are no undervalued or overvalued securities available.