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FIN 501 (31)
Chapter 12

CFIN501- Chapter 12- Return, Risk, and the Security Market Line.docx

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FIN 501
Edward Blinder

CFIN501 Chapter 12 Return Risk and the Security Market LineAnnouncements Surprises And Expected ReturnsExpected and unexpected returnsReturn on any stock traded in a financial market is composed of two partsoNormal or expected return from the stock is the part of the return that investors predict or expectDepends on the information investors haveBased on the markets understanding today of the important factors that will influence the stock in the coming yearoUncertain or risky partUnexpected information revealed during the yearTotalreturnexpectedreturnunexpectedreturnRERUAnnouncements and NewsGDP grows at a relatively high rate and suffers when GDP is relatively stagnant implicitly or explicitly think about what the GDP is likely to be for the coming yearoOnce announcedPrediction of GDP will already be factored into the expected part of the return ERoGDP is a surpriseeffect will be part of UDiscounted newsimpact is already a part of the stock price because the market already knew about itInnovation or the surprisedifference between the actual result and the forecastAnalyst had been expecting significantly sharper declinessituation was not a bad as previously thoughtKey factkeep in mind about news and prices news about the future is what mattersAnnouncementexpectedpartsurpriseoExpected part of any announcementpart of the information that the market uses to form the expectation ER of the return of the stockoSurprisenews that influences the unanticipated return on the stock UEfficient Frontier And Capital Asset LineMarkowitzfounder od Modern Portfolio TheoryoRelationship between return and risk characteristics of various financial instruments oTired to identify those portfolios that investors chooseoAssumed investors are risk adverse and rationaloInvestors would choose at every expected return level the assets and portfolios within riskTotal risk level is the important factor in reward of portfoliosportfolio preference of investorsInvestors found the minimum risk portfolios at every return level and choose these portfolios over the othersoPlot every financial instrument and portfolio in an economy in an expected return risk graph Find the minimum risk portfolios at every return levelEvery return level they obtain a parabola and the upper part of the parabolaefficient frontierEvery economywhen investors combine the risk free asset with efficient frontier they obtain the capital asset line CALoEvery rational investor will choose their optimal portfolio on CAL according to their preferred risk levelSharpe Lintner Mossin and Tobin developed the capital asset pricing modeloSystematic risk not total risk is the key factor in determining investment rewardsRisk Systematic Risk And UnsystematicImportant to distinguish between expected and unexpected returnsunanticipated part of the return from surprises is the significant risk of any investmentRisk freereceive exactly what we expect than the investment is perfectly predictableoRisk of owning an asset comes from surprisesunanticipated eventsSystematic and Unsystematic RiskSystematic riskrisk that influences a large number of assets market riskoHave market wide effectsUnsystematic riskrisk that influences a single company or a small group of companies unique assetspecific riskoRisks are unique to individual companirs r assetsUncertainties about general economic conditionsGDP interest rates inflation systematic risk1
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