INSTRUCTOR MANUAL
Instructor’s Manual for Principles of Finance
03/21/22
1
, Instructor’s Manual for Principles of Finance
Chapter 15
How to Think about Investi ng
Chapter Summary
Rates of return data generated by investments need to be risk adjusted. In order to do so, the
nature of the risks of individual stocks and of portfolios has to be taken into account.
Lecture Outline
15.1 Risk and Return to an Individual Asset
Calculating Total Return
The total return from an investment is the sum of two elements:
capital gains yield, or the price appreciation of the asset
dividend yield, or the portion of the return that comes from dividends paid by the asset
Capital gains yield is the percentage change in an asset’s value from the beginning of a period
to the end of the period. The dividend yield is the asset’s dividend payment divided by its price.
Not all stocks pay dividends.
Risk and the Investment Decision
A decision to invest in an asset is motivated by opportunity cost: investors will invest in an asset
if the asset will generate a rate of return that is at least equal to the return of the next best
comparable alternative.
This expectation is risk-adjusted—that is, it asks what an appropriate rate of return is for the
level of risk of the investment.
Average Return and Risk
The average return is determined as an arithmetic average: take the sum total of returns over a
period of time and divide that sum by the number of periods measured.
The standard deviation measures the volatility of returns as it measures how dispersed the data
is with respect to the mean (also called the average).
Interpreting Standard Deviation
A high standard deviation means a wide range of possible returns around the average, whereas
a low standard deviation means a narrow range of possible returns.
The wider the range of possible returns, the riskier the asset, and the narrower the range of
possible returns, the less risky an asset is.
03/21/22 2
Instructor’s Manual for Principles of Finance
03/21/22
1
, Instructor’s Manual for Principles of Finance
Chapter 15
How to Think about Investi ng
Chapter Summary
Rates of return data generated by investments need to be risk adjusted. In order to do so, the
nature of the risks of individual stocks and of portfolios has to be taken into account.
Lecture Outline
15.1 Risk and Return to an Individual Asset
Calculating Total Return
The total return from an investment is the sum of two elements:
capital gains yield, or the price appreciation of the asset
dividend yield, or the portion of the return that comes from dividends paid by the asset
Capital gains yield is the percentage change in an asset’s value from the beginning of a period
to the end of the period. The dividend yield is the asset’s dividend payment divided by its price.
Not all stocks pay dividends.
Risk and the Investment Decision
A decision to invest in an asset is motivated by opportunity cost: investors will invest in an asset
if the asset will generate a rate of return that is at least equal to the return of the next best
comparable alternative.
This expectation is risk-adjusted—that is, it asks what an appropriate rate of return is for the
level of risk of the investment.
Average Return and Risk
The average return is determined as an arithmetic average: take the sum total of returns over a
period of time and divide that sum by the number of periods measured.
The standard deviation measures the volatility of returns as it measures how dispersed the data
is with respect to the mean (also called the average).
Interpreting Standard Deviation
A high standard deviation means a wide range of possible returns around the average, whereas
a low standard deviation means a narrow range of possible returns.
The wider the range of possible returns, the riskier the asset, and the narrower the range of
possible returns, the less risky an asset is.
03/21/22 2
