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Part 3 Risk Jilin university College of economics Ding zhaoyong Outline of this part This part examines the relationship between expected return and risk for portfolios and individual assets. When the capital markets are in equilibrium, they determine a trade—off between expected return and risk. This part is composed by four chapters: 9 capital market theory: an overview( risk and return) 10 CAPM 11 APT 12 risk ,return and capital budgeting Chapter 9 Risk and return Chapter 9 Risk and return 9.1 Returns Dollar return If you buy some kinks of assets, your gain or loss from that investment is called the return on your investment. This return will usually have tow components. First, you may receive some cash directly while you own the investment. This is called the income component of your return. Second, the value of the asset you purchase will often change. In this case, you have a capital gain or capital loss on your investment. Total dollar return= dividend income +capital gain(loss) Total cash if stock is sold= initial investment+total return Chapter 9 Risk and return Percentage return It is usually more convenient to summarize information about return in percentage terms, rather than dollar return, because that way your return does not depend on how much you actually invest. The question we want to answer is : how much do we get for each dollar we invest. Percentage return=(dividends paid at end of period+change in market value over period)/beginning market value 9.2 Inflation and returns Real versus nominal returns The returns we calculated in the previous section are called nominal returns because they were not adjusted for inflation. Chapter 9 Risk and return Returns that have been adjusted to reflect inflation are called real return. The difference between nominal return and real return is important and bears repeating: Your nominal return on an investment is the percentage change in the number of dollars you have. Your real return on an investmen