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CHAPTER 5 Risk and Rates of Return ,[object Object],[object Object],[object Object]
Risk and Rates of Return ,[object Object],[object Object],[object Object]
Calculating Rates of Return for Stocks ,[object Object],[object Object],[object Object]
What is investment risk? ,[object Object],[object Object],[object Object],[object Object],[object Object]
Probability Distributions ,[object Object],[object Object]
Calculating Expected Returns for Stocks ,[object Object],[object Object]
Measuring the Risk of Stocks: The Variance of Returns ,[object Object],[object Object],[object Object],[object Object]
Selected Realized Returns,  1926 – 2001 ,[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object],[object Object]
Coefficient of Variation (CV) ,[object Object]
How Investors View Risk and Return ,[object Object],[object Object],[object Object]
Implications of Risk Aversion ,[object Object],[object Object],[object Object]
Diversification ,[object Object],[object Object],[object Object]
The Two Components of a Security’s Variance (Risk) ,[object Object],[object Object],[object Object]
The Expected Return on a Portfolio of Stocks ,[object Object],[object Object]
The Variance of Returns for a Portfolio of Stocks ,[object Object],[object Object]
Correlation Coefficient ,[object Object],[object Object],[object Object],[object Object],[object Object]
Correlation Coefficient-Cont’d ,[object Object],[object Object],[object Object],[object Object],[object Object]
The Variance of Returns for a Portfolio of Stocks ,[object Object],[object Object]
How Diversification Reduces Risk ,[object Object],[object Object],[object Object],[object Object],[object Object]
How Diversification Reduces Risk - Cont’d
Portfolio Risk Falls As You Add Securities
You Can’t Eliminate “Market Risk”
This Pattern Occurs Because of the Two Components of a Stock’s Variance (Risk): ,[object Object],[object Object],[object Object],[object Object],[object Object]
How Should We Measure Portfolio Risk Now? ,[object Object],[object Object]
How Do Investors View the Risk of a  Single Security  Held in a Portfolio?
Answer: “Beta” Measures a Stock’s Market Risk Covariance with the market Variance of the market
How to Interpret a Beta ,[object Object],[object Object],[object Object]
How To Interpret a Beta-Cont’d ,[object Object],[object Object],[object Object],[object Object]
Betas Are Calculated Using Regression Analysis 1.  Total risk = diversifiable risk + market risk 2.  Market risk is measured by beta, the sensitivity to market changes beta Expected return Expected market return 10% 10% - + ,[object Object],+10% stock Copyright 1996 by The McGraw-Hill Companies, Inc -10%
General comments about risk ,[object Object],[object Object],[object Object]
A model that relates an asset’s risk to its rate of return ,[object Object],[object Object]
General Comments About CAPM ,[object Object],[object Object],[object Object],[object Object]
Capital Asset Pricing Model k i  = k RF  +  B i  ( k M  - k RF  ) CAPM
CAPM Graphically: The Security Market Line Return BETA k RF SML SML Equation: k i  =  k RF  + B i ( k M  - k RF  )
Plotting the Security Market Line Return BETA . Risk Free  Rate  =  k RF Market Return = k M   Market Portfolio 1.0
The Security Market Line (SML): Calculating required rates of return ,[object Object],[object Object],[object Object]
An example: Equally-weighted two-stock portfolio ,[object Object],[object Object],[object Object],[object Object],[object Object]
Factors that change the SML ,[object Object],SML 1 k i  (%) SML 2 0  0.5   1.0 1.5 18 15 11 8    I = 3% Risk,  β i
Factors that change the SML ,[object Object],SML 1 k i  (%) SML 2 0  0.5   1.0 1.5  18 15 11 8    RP M  = 3% Risk,  β i
Verifying the CAPM empirically ,[object Object],[object Object],[object Object]
More thoughts on the CAPM ,[object Object],[object Object],[object Object]

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