BSNS108 Lecture Notes - Capital Asset Pricing Model, Standard Deviation
17 Sep 2013
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Topic 10- risk, return, portfolios, diversification and the capm. Expected returns depend upon possible outcomes weighted by their probabilities. This equation appears complicated but it is actually relatively straightforward. In simple terms it is: e(ra)= probability 1 x return 1 + probability 2 x return 2 . E(ra)=probability 1 x return 1 + probability 2 x return 2 + probability 3 x return 3. Suppose there are three possible future states of the world, and you have predicted the following returns for stocks bda and cec in these states. Variance and standard deviation in a simple model of states of the world. Standard deviation=spread of returns about the expected return. Again this formula looks difficult but when it is broken down it is actually quite straightforward. Exercise: expected return, variance and standard deviation in a simple model of states of the world.
