false

Study Guides
(247,963)

Canada
(121,192)

Ryerson University
(8,352)

Finance
(316)

FIN 501
(18)

Edward Blinder
(11)

Unlock Document

Finance

FIN 501

Edward Blinder

Summer

Description

FIN501 investment analysis I
CHAPTER 12 RETURN, RISK, AND THE SECURITY MARKET LINE
ANNOUNCEMENTS, SUPRISES, AND EXPECTED RETURNS
Risk that can be eliminated by diversification do not yield an expected reward; risk that cannot be eliminated by
diversification does yield an expected reward
Security market line (SML) shows the relationship between risk and return
ANNOUNCEMENT, SURPRISES, AND EXPECTED RETURNS
Return on any stock traded in a financial market is composed of two parts:
1. The expected return from the stock is the part of the return that investors predict or expect
2. The uncertain or risky part that comes from unexpected information revealed during the year
Total risk: an investment measured by the variance or standard deviation of its return
Total return: investment has expected return and unexpected return
o On average, the actual return equals the expected return
TOTAL RETURN - EXPECTED REUTRN = UNEXPECTED RETURN
R - E(R) = U
An announcement can be broken into two parts: anticipated (expected) plus surprise (innovation)
ANNOUNCEMENT = EXPECTED PART + SURPRISE
EFFICIENT FRONTIER AND CAPITAL ASSET LINE
In the modern portfolio theory, investors would choose at every expected return level the assets and portfolio with
minimum risk, assuming that investors are risk-averse and rational
o Finding the minimum risk portfolio at every return level plots a parabola and the upper part of the parabola
is called the efficient frontier
Capital asset line (CAL): When combining the risk-free asset with efficient frontier
RISK: SYSTEMATIC AND UNSYSTEMATIC
Systematic risk (market risk): risk that influences a large number of assets
o Uncertainties about general economic conditions, such as GDP, interest rate, or inflation
Unsystematic risk (unique or asset-specific risk): risk that influences a single company or a small group of companies
Total surprise component has a systematic and unsystematic component
R - E(R) = SYSTEMATIC PORTION + UNSYSTEMATIC PORTION
R - E(R) = U = m + ԑ
DIVERSIFICATION, SYSTEMATIC RISK, AND UNSYSTEMATIC RISK
Unsystematic risk is essentially eliminated by diversification, so a portfolio with many assets has almost no
unsystematic risk
Systematic risk is not eliminated by diversification, so a portfolio with many assets will still have systematic risk
SYSTEMATIC RISK AND BETA
Systematic risk principle: the reward for bearing risk depends only on the systematic risk of an investment
o The expected return on an asset depends only on its systematic risk
Beta coefficient (β): measure of the relative systematic risk of an asset
o Assets with betas larger (smaller) than 1 have more (less) systematic risk than average
EX. Suppose you put half of your money in BCE and half in TELUS. What would the beta of this combination be?
Bp= 0.5 x BCE+ 0.5 xTELUS
THE SECURITY MARKET LINE
EX. Consider Asset A with A(R )=20% anA β =1.6. Risk-free rfte is R=8%. Assume 25% of the portfolio is invested in Asset A.
We can calculate expected return
E(RP) = 0.25 x A(R ) + (1 – 0.f5) x R = 0.25 x 20% + 0.75 x 8% = 11%
Beta on portfolioPβ
βP= 0.25 x A + (1 – 0.25) x 0 = 0.25 x 1.6 = 0.4 FIN501 investment analysis I
It is possible for the percentage invested in Asset A to exceed 100% if the investor borrows at the risk-free rate and
invests the proceeds in stocks
EX. Suppose an investor has $100 and borrows an additional $50 at 8%, the risk-free rate. The total investment in Asset A would be $150, for
105% of the investor’s wealth
E(R ) = 1.50 x E(R ) + (1 – 1.50) x R = 1.50 x 20% + 0.50 x 8% = 26%
P A f
βP= 1.50 x A + (1 – 1.50) x 0 = 1.50 x 1.6 = 2.4
The reward-to-risk ratio must be the same for all assets in a competitive financial market
o Price and expected returns move in opposite direction - if Asset A’s price rise and expected return would
decline; Asset B’s price would fall and expected return would rise
(E(R ) – R ) / β = (E(R ) – R ) / β

More
Less
Related notes for FIN 501

Join OneClass

Access over 10 million pages of study

documents for 1.3 million courses.

Sign up

Join to view

Continue

Continue
OR

By registering, I agree to the
Terms
and
Privacy Policies

Already have an account?
Log in

Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.