Session 4: Defining and Measuring Risk

Looks at how we define risk in finance and alternate models for risk and return.

[marinabaskakova]

I cannot believe this stuff is available online for free! Thank you Sir, the way you explain is so thoughtful and clearly structured.

[zanjeerz]

Haven't heard Risk being explained so beautifully ! Thank you Prof ! Top notch sessions accessible to the entire world !

[AswathDamodaranonValuation]

Laney,
You are right. If you hold for 10 years, your return would be based on the original price and the face value which are both known. If your time horizon is a year, though, you will have to sell the bond at the end of the year and if interest rates have changed, you will get a different price back than the one you paid.

[akashpanmand]

I don't have economics background at all but the astonishing way you explain everything makes me want to learn more and more about Finance. Thank you very much for taking efforts and making such wonderful educational information available to general public. 🙌🏼

[lawriebeckett]

I'm coming into this as an 18 year old with no finance or economics experience, some of the terms require a bit of googling but it's fascinating all the different ways and models you can use to evaluate risk!

[masterintuitivethink]

🎯 Key Takeaways for quick navigation:

00:04 *📊 Defining Risk in Corporate Finance*
- Defining risk as a central measure in financial decision-making.
- Exploring conventional definitions of risk and how financial theory measures it.
- Introducing the concept of hurdle rates and their significance in project selection.
01:59 *🎯 Understanding Risk: Danger and Opportunity*
- Explaining risk as a combination of danger and opportunity.
- Highlighting the importance of balancing high returns with potential dangers.
- Emphasizing the need to assess the level of risk in investments for appropriate compensation.
04:21 *📉 Measuring Risk in Financial Theory*
- Defining risk by deviations of actual returns from expected returns.
- Illustrating risk through examples of investments with varying levels of certainty.
- Emphasizing that all risk lies in the future and the importance of forward-looking risk assessment.
07:13 *🔍 Distinguishing Market Risk from Firm-Specific Risk*
- Explaining the distinction between market risk and firm-specific risk.
- Emphasizing the role of diversification in mitigating firm-specific risks.
- Focusing on market risk as the primary concern in financial decision-making.
12:58 *⚡️ Evaluating Risk and Return Models in Finance*
- Discussing the flaws of the Capital Asset Pricing Model (CAPM) in predicting future returns.
- Introducing alternative models like arbitrage pricing and multi-factor models.
- Highlighting the challenges and limitations of these alternative models in practical application.

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[Josephus_vanDenElzen]

4:03 ; Risk = the deviation of actual return around an expected return

[samee]

Dr. Damodaran, What software do you use on slide 9 for market analysis and showing who owns stock in Disney?

[laneydaniels]

Im sorry, I didn't understand the example with the Bond risk for 1 year vs. 10 years. Why would the price change matter...if you've already purchased your T-Bond at a given price. Isn't the return based on purchase price, not current price? Or do I just have that point in regards to T-Bond wrong?

Thank You!!

[diyamahajan]

Are these classes same as the other corporate finance classes which are uploaded in 2017

[njabraham]

Diversified investors, in this case being large institutional investors, are also, as per your previous lecture, the most irrational. The first ones to pull out the cash in large volmes when they get wind of somehting, are the Institutional Investors. So how can you eliminate large institutional investors from the computation of the hurdle rate when irrationality is a risky feature? i didn't quite get this.

[affansiddhiqui]

You said you didn't want to carry the baggage of modern portfolio theory,
Professor i think you should take look at mathematician benoit mandelbrot's fractal model in "misbehaviour of market" (book)

[anweshroy]

Hey! Can anybody tell me why it is important for the marginal investor to be diversified? Is it because the CAPM or any other model only estimates market risk and if the marginal investors were not diversified, the model would not work?

[pratik]

You said CAPM model should be used, but did not tell us what is CAPM model in detail?

[kaushalthakkar]

There is a gold mine here and still not so popular, the world is definitely moving in the wrong direction surfing for wrong content.

[brijeshyadav]

Sir can please make this video in Hindi.. i can't. Understand the video becoz of the English

[sheenabhdhar]

Another thing about the assumption about the marginal investor, in case most marginal investors are institutions, doesn't that reduce the corporate governance score of the company? Therefore, isn't it true that for the fundamental assumption of the CAPM to hold true, the corporate governance of the company must, in most cases, be flawed?

[sheenabhdhar]

I don't understand how low price to book companies can be riskier than high price to book companies. In the case of low price to book companies, we have a higher degree of assurance that if the company liquidates, there is a higher probability that we'll be able to recover a larger share of our initial investment (if P/BV ratio > 1) and we might even make more than our initial investment upon liquidation (if P/BV ratio < 1). In contrast, isn't there a greater risk in investing in high P/BV ratio companies? Isn't one essentially overpaying for the assets in place of these companies? For example, if the P/BV ratio of a company is 12, I would be very uncomfortable in investing in that company because if my assumptions about the cash generating capacity of the company go wrong and the company liquidates, I'll only receive a dollar back for every 12 dollars that I invested. Compared to that, if the P/BV ratio of a company is 1.5, I can be much more comfortable investing in the company knowing that even if the company liquidates, I'll get back 66.67% of my initial investment. Assuming that the assets aren't overvalued by the company's books, of course.