B A 323 Lecture Notes - Lecture 11: Squared Deviations From The Mean, Standard Deviation, Systematic Risk
20 May 2018
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Chapter 11 – Risk and Return
Key Concepts
• know how to calculate expected returns
• understand
o the impact of diversification
o the systematic risk principle
o the security market line and the risk-return trade-off
Expected Returns
• expected returns are based on the probabilities of possible outcomes
• pi = poaility of state i ouig
• Ri = the expected return on an asset in state i
Variance & Standard Deviation
• variance and standard deviation measure the volatility of returns
• variance = weighted average of squared deviations
• std dev = square root of variance
Portfolios
• Portfolio = collection of assets
• A asset’s isk ad etu ipat the isk ad etu of the potfolio
• The risk-return trade-off for a portfolio is measured by the portfolio
expected return and standard deviation, just as with individual assets
• Portfolio expected returns
o Portfolio = collection of assets
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2
o A asset’s isk ad etu ipat the isk ad etu of the
portfolio
o The risk-return trade-off for a portfolio is measured by the
portfolio expected return and standard deviation, just as with
individual assets
• portfolio risk: variane and std dev
o Portfolio standard deviation is NOT a weighted average of the
standard deviatio of the opoet seuities’ isk
▪ If it were, there would be no benefit to diversification.
Announcements, News, and Efficient Markets
• Announcements and news contain both expected and surprise
components
• The surprise component affects stock prices
• Efficient markets result from investors trading on unexpected news
o The easier it is to trade on surprises, the more efficient markets
should be
• Efficient markets involve random price changes because we cannot
predict surprises
Returns
• total return = expected return + unexpected return
o R = E(R) + U
o R = E(R) + m + ε
• unexpected return (U) = systematic portion (m) + unsystematic
portion (ε)
Systematic Risk
• factors that affect a large number of assets
• o-divesifiale isk
å
=
=
m
1j
jjP
)R(Ew)R(E
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Document Summary
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