FIN 300 Chapter Notes - Chapter 13: Capital Asset Pricing Model, Risk-Free Interest Rate, Systematic Risk
28 Jun 2018
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FIN – Chapter 13 – Return, Risk and the security market line
Two states of the economy – there are only the two possible situations
Expected return – the return on a risky asset expected in the future
Risk premium = expected return – risk free rate
= E(Ru) - Rf
the expected return on a security or other assets is equal to the sum of the possible returns
multiplied by their probabilities
calculate variance of the returns on two stocks – determine squared deviations form the
expected return, then multiply each possible squared deviation by its probability. Add these up
and result is the variance
standard deviation is always the square root of the variance
portfolio – a group of assets such as stocks and bonds held by an investor
portfolio weight – the percentage of a portfolio’s total value that is invested in a particular
asset
let xi stand for the percentage of money in asset I, n number of assets
expected return = E(Rp) = x1 X E(R1) + x2 X E(R2) + … + xn X E(Rn)
total return = expected return – unexpected return
R = E(R) + U
On average the actual return equals the expected return
When we discount an announcement or a news item, we say that it has less of an impact on the
price because the market already knew much of it
The difference between the actual result and the forecast is sometimes called the innovation or
surprise
Announcement = expected part + surprise
Systematic risk – a risk that influences a large number of assets. Also, market risk
Unsystematic risk – a risk that affects at most a small number of assets. Also, unique or asset
specific risk
Surprise component= U = systematic portion + unsystematic portion
R = E(R) + systematic portion + unsystematic portion
R = E(R) + m + ε
The process of spreading an investment across assets is called diversification
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Fin chapter 13 return, risk and the security market line. Two states of the economy there are only the two possible situations. Expected return the return on a risky asset expected in the future. Risk premium = expected return risk free rate. On average the actual return equals the expected return. When we discount an announcement or a news item, we say that it has less of an impact on the price because the market already knew much of it. The difference between the actual result and the forecast is sometimes called the innovation or surprise. Systematic risk a risk that influences a large number of assets. Unsystematic risk a risk that affects at most a small number of assets. Surprise component= u = systematic portion + unsystematic portion. R = e(r) + systematic portion + unsystematic portion. The process of spreading an investment across assets is called diversification.
