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Okay, so first session on risk and return.

Â We're basically going to first of all we're going to

Â think a little bit about how we calculate a periodic return and

Â a periodic return is basically the return on any given period.

Â Now, in finance we never look at one period.

Â Sometimes we may look for any specific purpose.

Â But when want to evaluate the performance of assets,

Â what we basically do is to aggregate performance over time.

Â And in order to do that we need to aggregate information into statistics into

Â measures that tell me something about the return characteristics and

Â the risk characteristics of different assets.

Â So we're going to look at two different ways of calculating mean returns, and

Â two different ways of assessing risk.

Â And importantly, in everything that follows in this session,

Â we're not going to be looking at any formula,

Â this session is complimented by two technical notes and all the formulas and

Â expressions that you need are contained in those two technical notes.

Â So what we're going to do here is to maximize the intuition, the understanding

Â of each of these variables that are used to describe returns and risk.

Â And then you're going to,

Â go a little bit deeper, into the actual calculation of these managers.

Â And then you're going to test yourself, with a little problem set in order to

Â see whether you're understanding the concepts or not.

Â So, we're going to start right away.

Â And the first thing that we're going to do is to define a periodic return.

Â And first thing about it, about this in the simplest possible way.

Â If you buy an asset, if you buy a share of stock and

Â you buy it at the beginning of the year and you sell it at the end of the year

Â when you compare the price at which you buy and the price at which you

Â sell that price might have gone up or it might of gone down.

Â If the price goes up, then you obtained a gain, and we call that a capital gain.

Â And if the price went down, then you obtained a loss and

Â we call that a capital loss.

Â So be, when you compare the price at the beginning of the period and

Â the price at the end of the period,

Â one of the two sources of return is what we call a capital gain, or a capital loss.

Â Now on top of that, many assets actually pay you a cash flow.

Â Some companies pay dividends.

Â Some bonds pay coupons and

Â that basically is the cash flow that you put into your pocket.

Â And it will be part of your return.

Â So again, if you buy a share at the beginning of the period and

Â sell it at the end of the period, not only you can get that capital gain or

Â loss, which is given by the change in price between the beginning and

Â the end of the period, but you also can pocket the cash flow, which again.

Â Could be a dividend, could be an interest payment if it's a bond, and on,

Â and on, and on.

Â Once you put together these two sources of returns,

Â then that is what you actually get your return.

Â Except for the fact that we need one more step.

Â And the one more step that we need is typically we express everything,

Â both the change in price and the cash flow that we get,

Â relative to the price at the beginning of the period.

Â And that basically means, well, that the reason for this is simple is,

Â it's not the same thing to actually get a capital gain and a cash flow when you

Â paid $2 for a share of the stock than when you paid $10 for a share of the stock.

Â So suppose that between the beginning and

Â the end of the period and there was a capital gain of $1.

Â And you actually got a dividend of $1.

Â Well that's a $2 gain that you actually got.

Â One from the changing price and one from the cash that you put in your pocket.

Â So if you paid$2 for

Â that share of the stock then you actually got a very big return.

Â That is, you got $2 in terms of

Â 3:44

gain compared to $2 that you paid at the beginning, but if you had paid 10 or

Â 20, or $30 for that share, in proportional terms what you

Â actually got in terms of return is much lower when you pay 10, 20, or $30.

Â So what we typically do, in order to calculate that return, is to standardize,

Â to divide everything by the price that we paid at the beginning of the period.

Â So you can put now in the back of your head, and

Â again I don't want to do any formulas at this point.

Â But in order to calculate a return, you basically need two things.

Â You need a change in price between the beginning and the end of the period.

Â You need to know the cash flow that you're putting in your pocket,

Â if any between the beginning and the end of the period, and

Â once you have those two, components you add them up and you

Â divide the whole thing by the price that you paid at the beginning of the period.

Â All right, so

Â those are the two sources of gains that you get when you buy your share of stock.

Â And now we're going to look at a set of data.

Â And, and let me clarify a few things about the data that you're seeing.

Â You're seeing there three equity markets.

Â And, it's important that we understand that this is equity.

Â This is not debt.

Â So, these are stock markets.

Â These are broad diversified indices.

Â This is not, for example, in the case of the US,

Â the widely used S&P 500, all these are Morgan Stanley indices.

Â And it doesn't really matter, Morgan Stanley, Financial Times, Dow Jones.

Â There are many providers of data, this just happens to be Morgan Stanley data.

Â And they are basically broad indicators of the performance of the equity market in

Â each of the three countries that you are seeing there.

Â Now, in the last column you have the world market, and

Â that is basically an aggregation of all the equity markets,

Â developed markets and emerging markets put together into one.

Â So that world equity market is basically the composite of developed and

Â emerging markets all together and

Â all expressed in the same currency to which I would get to in just a minute.

Â So.

Â A couple of characteristics about those returns.

Â Characteristic number one they are, all of them, what we call total returns.

Â And total returns basically mean that we don't leave anything out.

Â That means that we're putting together the change of price, between the beginning and

Â the end of the period.

Â But we're also putting together the cash flows, paid by the companies in the index.

Â So when you look at, for example, that 10.7% for the year 2004.

Â In the case of the US, that means that when you put together the change in

Â the value of the index between the beginning and

Â the end of the period, and you put together the cash flow,

Â the dividends paid by all the companies in the index.

Â When you aggregate those two things and put it relative to the value of

Â the index at the beginning of the period you get that 10.7%.

Â Okay. So characteristic number one of

Â those returns is that they, they are again they are total returns and that

Â means we're putting together all of the sources for which we can get a return and

Â that means capital gains or losses and dividends paid by these companies.

Â Characteristic number two.

Â All of them are expressed in terms of dollars.

Â If you're actually looking at those three first countries the,

Â the local currency in each country's different and

Â typically we would express the returns in that particular currency.

Â Now because we want to make some comparisons, and

Â we will make those comparisons a few minutes from now.

Â We want to put everything in the same currency and that currency is the dollar.

Â And we also do that because if you look at the last column, that world market

Â portfolio we're aggregating many countries with many different currencies and

Â that is like adding apples and oranges, it doesn't really make any sense.

Â Unless you add the map in the same currency and that's why we're,

Â again we're using the dollar as that particular currency.

Â So keep in mind that the characteristics of those returns.

Â Number one is that they're expressed in dollar,

Â number two that they still have their total returns and

Â that they're put together all the sources from where we can get gains.

Â All right?

Â Now, we're going to go back.

Â And we're going to think a little bit in terms of the in terms of the following and

Â that is suppose that I ask you to tell me something about the performance of

Â the US Market or the Spanish Market or

Â the Egyptian Market, well you're not going to be looking at one year you,

Â you ideally would like to be looking at a relatively long period of times.

Â Which means that you're going to have a series of many returns they could be

Â annual returns, they could be monthly returns, they could be daily returns.

Â What we have here are annual returns, the ones that were looking at, but ideally if

Â I want to be able to tell you something about the relative performance of the U.S.

Â market, the Spanish market or the Egyptian market or

Â any other market then I would like to look at a longer period of time.

Â And the problem is not a problem but

Â what happens is that when I am looking at a long period of time you know,

Â just looking at a series of returns is not going to help me.

Â Maybe making a little graph might help me a little bit, but maybe not a whole lot.

Â So what I need to do is to summarize information.

Â And summarizing information basically brings im,

Â implies bringing all the numbers together into one specific measure.

Â And that measure could be something that describes returns, or

Â something that describes risk, or something that describes,

Â as we're going to discuss in the next session, risk adjusted returns.

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