Chapter 7: RISK, RETURN, AND THE CAPITAL ASSET PRICING MODEL
Return = capital gain (loss) return + income yield(if any)
P1− P 0 CF 1 CF 1 P 1 P 0
Return = + =
P 0 P0 P0
e.g, A stock had an initial price of $58 per share, paid a dividend of $1.25 per share during the
year, and had an ending price of $75.
The percentage total return R = [$1.25 + ($75 - 58)]/$58 = 31.47%
—> CF (cash ﬂow) is the dividend here
—> the initial price (P0) is 58 and the ending price (P1) os 75
—> Main principal: Investors like higher return and do not like higher risk! Probability Distributions
—> Probability distributions are used to describe the certainty of returns by listing all possible
returns and their probabilities.
—> Graphically, the tighter (i.e., more peaked) the probability distribution, the more likely it is
that the actual returns will be close to the expected value.
—> The tighter the probability distribution, the lower the risk assigned to a stock.
Expected return = The weighted average of outcomes
Standard deviation = A measure of the tightness of a probability distribution giving an idea of
how far above or below the expected value the actual value is likely to be
—> EQ calculate the expected return and SD of the stocks Coefﬁcient of Variation (CV) = shows the risk per unit of return and captures the effects of both
risk and return, help us to decide in which assets we want to invest
CV = Standard deviation / expected return
CVMicro = 65.84% / 15% = 4.39
CVBig = 19.36% / 15% = 1.29
Expected Return and Risk for Portfolios
—> portfolio = a collect