0:00

[MUSIC]

Â So before we finish this session let's do two more things.

Â First, let me highlight once again that of these two ways of measuring risks,

Â both of them are what we call modern portfolio They come from the beginning

Â of modern portfolio theory but there are many other ways of measuring risk.

Â And, and that is important that you keep that in mind, because we're not going to

Â see more ways of measuring risk in this course, but if you ever take a course on

Â portfolio management, if you ever take a course on investment, that you will see

Â that there're many other ways of assessing the risk of, of different assets.

Â Now, all that being said in terms of risk, it's also important that, that you keep

Â in mind that the ways that we calculate risk actually may get very complicated.

Â But sometimes people think in very simple ways.

Â Sometimes people think in terms of the money that they can lose, or

Â sometimes people tend to think on how frequently they can lose money, or

Â how much money they can lose.

Â And so risk is a little bit sometimes we say in finance,

Â in the eyes of the beholder.

Â We might try to quantify many of these things.

Â We may try to get very sophisticated in terms of many of these things, but

Â at the end of the day, individual and

Â sometimes institutional investors think of risk in very different and sometimes in

Â more simple ways than we actually, people working in finance, attempt to do.

Â So to wrap up this session let's go back for

Â a minute, and let's try to highlight what are the main concepts that we discussed.

Â Concept number one was the concept of periodic returns.

Â Or simply the returns on any given period.

Â That is basically the combination of the capital gain or loss.

Â And that is basically given by the change of price between the beginning at the end

Â of any given period, and the cashflow, if any, that you actually put in your pocket.

Â When you put together the changing price and the cash flow that you might have put

Â in your pocket, and you standardize everything by the value that

Â you paid at the beginning of the period, that's what we call the periodic return.

Â And typically we're not happy enough with finance with one periodic return,

Â we want to have actually many periodic returns.

Â Many monthly returns, many annual returns.

Â So we can say something about the return and

Â the risk characteristic of these assets.

Â Now, once we have many of those periodic returns,

Â then we need to aggregate information.

Â And the way that we aggregate that information,

Â is by calculating some numbers that tell us something about the return of an asset,

Â and something that tell us some, some information about the risk of the asset.

Â There's three ways of calculating mean returns, of which we have explored two.

Â We explored the arithmetic mean return and the geometric mean return.

Â The arithmetic mean return is simply an average.

Â There's been high returns, low returns, positive returns, negative returns.

Â And in the typical period, this has been a particular return.

Â That number does not, and I stress that number does not give you

Â the mean on your rate at which your capital evolved over time.

Â That is the geometric mean return, which is the other definition that we've seen.

Â Geometric mean return is precisely what you get in any given period,

Â compounded over time on average.

Â So basically that's 7.7% if you remember that we've seen for

Â the world market, gives you the mean annual rate,

Â at which a capital investor in the world equity market evolved over time.

Â And that is the same number that you would get if you actually expose your

Â capital to all the returns of the ten years that, that we explore.

Â Second thing to, important to keep in mind about this mean returns.

Â Remember the relationship between the two.

Â The arithmetic mean return is always larger than or

Â equal to the geometric mean return.

Â But remember for all interesting assets in finance, which have some volatility all of

Â them, then the arithmetic mean return is higher than the geometric mean return.

Â Second important thing is that this difference is increasing in the volatility

Â of the asset, it's increasing in the variability of the asset.

Â And the reason that that is important is, remember the case of the Russian market.

Â I could actually be telling you about a very volatile market that has a very

Â high arithmetic mean return, but

Â the geometric mean return may be far lower or may even be a negative.

Â Particularly when we talked about volatile assets,

Â you shouldn't be happy enough we're talking about mean returns.

Â You want to know what type of mean returns you're reading about, or

Â you're talking about, or you're discussing about.

Â You want to know whether they're arithmetic or

Â geometric mean returns, because only the latter will tell you the rate at

Â which your capital invested in this particular asset evolved over time.

Â And finally we talked a little bit about risk.

Â And remember, there are many ways of actually thinking about the risk of

Â an asset, but there are two that come from more than portfolio theory.

Â Those two are what we call,

Â volatility, or the standard deviation of returns, and beta.

Â And these two are actually different ways of assessing risk.

Â One, is what we call an absolute measure of risk.

Â And it's absolute because we focus, we look at one specific asset.

Â That's the standard deviation of returns.

Â It basically gives you an idea of uncertainty,

Â the degree of fluctuations and the degree of variability in the returns of an asset.

Â And remember, we use it in relative terms, basically,

Â because the higher this number is, the more volubility we

Â observe in these returns over time, and the more uncertainty we're going to have,

Â in terms of the returns that we might get in the future for these particular assets.

Â So the higher this number, the higher the fluctuations have been, and

Â the higher is the uncertainty that, that we get.

Â The other measure of risk is what we call Beta.

Â And beta remember, is a measure of risk relative to the market.

Â Here the question is whether an asset magnifies or

Â mitigates the volatility of the market.

Â So an asset can actually magnify the volatility of the market,

Â it may go up by more and fall by more than the market, or

Â it can actually mitigate the volatility of the market.

Â It can go up by less and down by less than the market does.

Â And when that goes pretty much just like the market, that is a beta of one.

Â In the first case, is a beta higher than one.

Â And in the other case, it's a beta lower than one.

Â Final thing, and with this we finish this session.

Â This final thing sort of gives us the link to what's coming in the next session.

Â How do we go from beta to from standard deviation to beta?

Â Well, there, there's one way of thinking about this.

Â And the one way of thinking about this, very simply, is, if I put all my money in

Â one asset and I believe that the standard deviation is a proper measure of risk,

Â then that's the way that I'm going to perceive the risk of that asset.

Â Uncertainty about the returns that I'm going to get.

Â The higher this number, the more uncertainty I'm going to have.

Â So, that's basically one way of thinking about risk.

Â Now, what happens if instead of putting all my money in this particular asset

Â in isolation, I actually start building a portfolio with different assets.

Â Well, what happens is that part of the risk of

Â each individual asset diversifies away.

Â What does it mean diversify away?

Â Well, that if I have many assets in my portfolio, on any given day, week, or

Â month some assets will go up and some assets will go down.

Â I'll have some good news and some bad news on

Â the different companies in my portfolio, and a lot of those things will cancel out.

Â Well, many of things will cancel out, but many things will remain exposed too.

Â And that is what we call sometimes, the risk that we cannot diversify away.

Â And that is precisely what Beta measures.

Â So the way we go from volatility into beta,

Â is thinking if I have all my money invested in this one individual asset,

Â I assess risk with the volatility of the asset.

Â If I have this asset within a diversified portfolio, a lot of this risk diversifies

Â away and only the risk that I cannot diversify away, which is measured by beta,

Â is the risk I get to bear when I have this asset built into a diversified portfolio.

Â So, we'll discuss some of these issues in the second session.

Â This is the end of session one.

Â See you soon.

Â [MUSIC]

Â