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Chapter 13

MGT 181 Chapter Notes - Chapter 13: Risk-Free Interest Rate, Expected Return, Risk Premium

Rady School of Management
Course Code
MGT 181

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Return, Risk, and the Security Market Line
Expected Returns and Variances
Expected Return
Expected return
The return on a risky asset expected in the future
Risk premium = expected return - risk free rate
To get the expected avg for an asset across different economic conditions is calculated
by multiplying the probability of the economic situation by the return in that situation and
then adding up all the results for all periods
Calculating the Variance
Take the square of the standard deviation, multiply by the probability
Do this for every value and then add them up
A group of assets such as stocks and bonds held by an investor
Portfolio Weights
The percentage of a portfolio’s total value that is invested in a particular asset
Portfolio Expected Returns
To calculate your return from your portfolio, multiply the percentage of your portfolio a
given asset is by its return, repeat for every asset, and then add them up
Portfolio Variance
Multiply the variance of each asset by its weight and add them up
Announcements, Surprises, and Expected Returns
Expected and Unexpected Returns
Total return = expected return + unexpected return = E(R) + U
Expected returns
The part that people can predict
Based on the market’s understanding today of things that could influence the
company/stock price
Unexpected returns
Come from unexpected news that you cannot predict
Flash decisions, press conferences, economics, natural disasters, etc.
Announcements and News
The way the stock changes depends on the stock’s relationship to the news, and the
impact reflected in the change in price depends on how much of the announcement is
actually new information
Discounted announcement
An announcement that isn’t news
Already predicted
Another name for new information
Announcement = expected part + surprise
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