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Lecture 8

ADM2350 Lecture 8: Untitled8
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Department
Administration
Course
ADM2350
Professor
Anna Dodonova
Semester
Fall

Description
Chapter 7: return and risk (SD measures risk) e.g, average risk of returns 5%,6%,7% = (5 + 6 + 7) /3 = 6% SD: i. asset specific ii. market Beta a = beta for stock a (Ra - Ref) / Beta A = (Rm - Rrf) / Beta m ****CAPM: Return A = Risk free rate + Beta A * (Return on market - Return risk free assets)**** MRP = (Return on market - Return risk free assets) e.g, : βi= 1.5, RF = 3%, r M 10% draw SML: r =i3% + 1.5 × (10% - 3%) = 13.5% for any stock, there’s return (R) and risk (risk is measured by Beta) —> if S&P 500 goes up by 3%, beta tells you that your return goes up by Beta i of 3& —> high beta = high return e.g, Beta A = 1.2 Brf = 0 Return A = 18% risk free rate = 0.07 weights must add to 100% (e.g, 25 and 75) Beta for the portfolio = Wi * Brf + w2 * Ba e.g, for 25% invested in A, 75% in risk-free asset: βp = 0.25 × 1.2+ 0.75 × 0 = 0.3 -> here its kinda moved around new e.g, Asset A has an expected return of 12% and a beta of 1.40. Asset B has an expected return of 8% and a beta of 0.80. Are these assets valued correctly relative to each other if the risk-free rate is 5%? Ra = 12% Ba = 1.4 Rb = 8% Bb = 0.8 Rrf = 5% (Ra - Rrf) / Ba = (Rb - Rrf) / Rb For A: (.12 - .05)/1.40 = .05 For B: (.08 - .05)/0.80 = .0375 What would the risk-free rate have to be for these assets to be correctly valued? (.12 - Rf)/1.40 = (.08 - Rf)/0.80 Rf = .02666 New e.g, assume stock A has an expected return of 20% and beta = 1.2; the risk-free rate is 4%. Find the beta of a stock B th
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