FM (Bringing Together Risk and Return)

BRINGING TOGETHER RISK
AND EXPECTED RETURN:

MARKET VALUES, OPPORTUNITY COSTS
AND MARKET EFFICIENCY
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.
Gain BUY - 10,000.00

SELL - 12,500.00
RETURN - 2,500.00 GAIN
Loss BUY - P 10,000.00

SELL - P 9,500.00
RETURN – 500.00 LOSS
FACTORS AFFECTING THE RETURN
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.
TotaI Return 2,650.00 Percentage Return 26.49

Investment 10,000.00 Number or Years 3
0.2649 Annualized Percent Return 8.83 %
Percentage Return 26.49 %
UNDERSTANDING RISK
Risk means the possibility you'll lose some or even
all of the money you invest.
TYPE OF RISK
NONSYSTEMIC RISK SYSTEMIC RISK

NONSYTEMIC RISK
Risk you can avoid
INVESTMENT RISK - There's investment risk in choosing to put your

money into one company rather than another.
MANAGEMENT RISK - There's management risk that a company's

officers may make serious errors.
SYTEMIC RISK
Risk you can't control
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
RECESSION RISK - A recession, or period of economic slowdown,

means many investments could lose value and make investing seem riskier.
POLITICAL RISK - With the increasing interaction of the world's

markets, political climates around the world can affect the value of your
domestic and international investments.
RISK TOLERANCE
You can build your risk tolerance — or compensate for it — in several ways:
Discuss what your

Start investing slowly Keep track of stock impressions of the
and stock mutual fund Keep track of what's
in investments that market are, and talk
performance, so you happening in the
don't require constant about any changes
get used to their values markets at large
monitoring and you’re considering in
gradually expand your moving up and down investment strategy
horizons. with your financial
adviser.
RISK TOLERANCE
You can build your risk tolerance — or compensate for it — in several ways:
Discuss what your

Start investing slowly Keep track of stock impressions of the
and stock mutual fund Keep track of what's
in investments that market are, and talk
performance, so you happening in the
don't require constant about any changes
get used to their values markets at large
monitoring and you’re considering in
gradually expand your moving up and down investment strategy
horizons. with your financial
adviser.
Market value (also known as OMV, or "open market valuation") is the price
an asset would fetch in the marketplace, or the value that the investment
community gives to a particular equity or business. It is also commonly used
to refer to the market capitalization of a publicly traded company, and is
calculated by multiplying the number of its outstanding shares by the current
share price.
UNDERSTANDING MARKET VALUE
A company’s market value is a good indication of investors’
perceptions about its business prospects. The range of market
values in the marketplace is enormous, ranging from less than 1
million for the smallest companies to hundreds of billions for the
world’s biggest and most successful companies.
Market value is also dependent on numerous other factors, such as the sector in
which the company operates, its profitability, debt load, and the broad market
environment. For example, Company X and Company B may both have Php
100 million in annual sales, but if X is a fast-growing technology firm while B
is a stodgy retailer, X’s market value will generally be significantly higher than
that of Company B.
In the example above, Company X may be trading at a sales multiple of 5,

which would give it a market value of Php 500 million, while Company B may
be trading at a sales multiple of 2, which would give it a market value of Php
200 million.
COST
FORMULA AND CALCULATION OF
OPPORTUNITY COSTS
Opportunity Cost=FO−CO
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
The key difference is that risk compares the actual performance of an

investment against the projected performance of the same investment, while
opportunity cost compares the actual performance of an investment against
the actual performance of another investment.
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.
At its core, market efficiency is the ability of markets to incorporate

information that provides the maximum amount of opportunities to purchasers
and sellers of securities to effect transactions without increasing transaction
costs.
3 DEGREES OF MARKET EFFICIENCY
Weak Form Semi-strongForm StrongForm




Weak Form
The weak form of market efficiency is that past price
movements are not useful for predicting future prices. If
all available, relevant information is incorporated into
current prices, then any information relevant information
that can be gleaned from past prices is already
incorporated into current prices. Therefore future price
changes can only be the result of new information
becoming available.
Semi-Strong Form
The semi-strong form of market efficiency assumes that
stocks adjust quickly to absorb new public information so
that an investor cannot benefit over and above the market
by trading on that new information.
Strong Form
The strong form of market efficiency says that market
prices reflect all information both public and private,
building on and incorporating the weak form and the
semi-strong form. Given the assumption that stock
prices reflect all information (public as well as private),
no investor, including a corporate insider, would be able
to profit above the average investor even if he were
privy to new insider information
THE BOTTOM
LINE
In the real world, markets cannot be absolutely
efficient or wholly inefficient. It might be reasonable
to see markets as essentially a mixture of both,
wherein daily decisions and events cannot always be
reflected immediately in a market. If all participants
were to believe the market is efficient, no one would
seek extraordinary profits, which is the force that
keeps the wheels of the market turning.
h a nk
T ou po!
y

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BRINGING TOGETHER RISK

AND EXPECTED RETURN:

Gain BUY - 10,000.00

Loss BUY - P 10,000.00

TotaI Return 2,650.00 Percentage Return 26.49

NONSYSTEMIC RISK SYSTEMIC RISK

INVESTMENT RISK - There's investment risk in choosing to put your

MANAGEMENT RISK - There's management risk that a company's

RECESSION RISK - A recession, or period of economic slowdown,

POLITICAL RISK - With the increasing interaction of the world's

Discuss what your

Discuss what your

In the example above, Company X may be trading at a sales multiple of 5,

The key difference is that risk compares the actual performance of an

At its core, market efficiency is the ability of markets to incorporate

Weak Form Semi-strongForm StrongForm

Weak Form Semi-strongForm StrongForm

Weak Form Semi-strongForm StrongForm

Weak Form Semi-strongForm StrongForm

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