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    Risk, Return, & The Capital Asset Pricing Model

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    Elyza Bartolome
    The document discusses key concepts related to risk, return, and the Capital Asset Pricing Model (CAPM). It defines investment return, risk, and different types of risk including stand-alone risk and market risk. Market risk cannot be eliminated through diversification, while diversification can reduce firm-specific or diversifiable risk. The CAPM holds that the expected return of an asset is determined by its beta, or level of non-diversifiable market risk. It also introduces the security market line which portrays the relationship between risk and required return in the CAPM.

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    Risk, Return, & The Capital Asset Pricing Model

    Uploaded by

    Elyza Bartolome
    38 views19 pages
    The document discusses key concepts related to risk, return, and the Capital Asset Pricing Model (CAPM). It defines investment return, risk, and different types of risk including stand-alone risk and market risk. Market risk cannot be eliminated through diversification, while diversification can reduce firm-specific or diversifiable risk. The CAPM holds that the expected return of an asset is determined by its beta, or level of non-diversifiable market risk. It also introduces the security market line which portrays the relationship between risk and required return in the CAPM.

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    Financial Management

    Original Title

    Risk and Return

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    The document discusses key concepts related to risk, return, and the Capital Asset Pricing Model (CAPM). It defines investment return, risk, and different types of risk including stand-alone risk and market risk. Market risk cannot be eliminated through diversification, while diversification can reduce firm-specific or diversifiable risk. The CAPM holds that the expected return of an asset is determined by its beta, or level of non-diversifiable market risk. It also introduces the security market line which portrays the relationship between risk and required return in the CAPM.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    38 views19 pages

    Risk, Return, & The Capital Asset Pricing Model

    Uploaded by

    Elyza Bartolome
    The document discusses key concepts related to risk, return, and the Capital Asset Pricing Model (CAPM). It defines investment return, risk, and different types of risk including stand-alone risk and market risk. Market risk cannot be eliminated through diversification, while diversification can reduce firm-specific or diversifiable risk. The CAPM holds that the expected return of an asset is determined by its beta, or level of non-diversifiable market risk. It also introduces the security market line which portrays the relationship between risk and required return in the CAPM.

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    © All Rights Reserved
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    of 19

    Risk, Return, & the Capital Asset

    Pricing Model

    1
    Topics in Chapter
     Basic return concepts
     Basic risk concepts
     Stand-alone risk
     Portfolio (market) risk
     Risk and return: CAPM/SML

    2
    What are investment returns?
     Investment returns measure financial results
    of an investment.
     Returns may be historical or prospective
    (anticipated).
     Returns can be expressed in:
     (P) Peso terms.
     (%) percentage terms.

    3
    Basic Formula for Return
    Fixed Returns
    Lesser risk since the return is fixed
    . An investment costs P1,000 and is
    sold after 1 year for P1,100

    Peso return:
    Received - Invested
    P1,100 - P1,000 = P100
    Percentage return:
    Return/Invested
    P100/P1,000 = 0.10 = 10%
    6
    Variable Income (series of
    time)
     Return is computed by getting the
    average return
    Variable Income (Probabililty
    based)

     Normal 40% Return 20%


     Bad 30% Return 5%
     Good 30% Return 35%
    WedTech Co

     Normal 40% Return 20% = .08


     Bad 30% Return 5% = .015
     Good 30% Return 35% = .105
     =Expected ave return = 20%
    Notes
     Expected Rate of Return- return that
    expected to realize.
     Required rate of Return – Minimum
    Rate of return acceptable by the
    investor
     Actual Rate of Return- Return
    actually earned
     Market Equillibrium- Required rate
    of return is equal to expected return
    What is investment risk?

     Typically, investment returns are not known


    with certainty.

     Investment risk pertains to the probability of


    earning a return less than expected.

     Greater the chance of a return far below the


    expected return, greater the risk.
    11
    Stand-Alone Risk
     Standard deviation measures the stand-
    alone risk of an investment.
     The larger the standard deviation, the
    higher the probability that returns will
    be far below the expected return.

    12
    Standard deviation
    Risk Aversion and Risk
    Premium
     Risk Aversion – the higher the risk the
    higher the return.

     Risk Premium –difference between


    expected return against Required rate
    of Return
    Porfolio
     Collection of assets or securities that a
    particular firm has for it investor.
    > Risk, > Return, (both + & -)

    Stand – Alone Risk Risk in Portfolio Context


     a. Diversifiable

     b. Market Risk
     Quantified by Beta & used in
     CAPM: Capital Asset Pricing Model
     Relationship b/w market risk &
    required return as depicted in SML

     Req’d return =
     Risk-free return + Mrkt risk Prem(Beta)
     SML: ri = rRF + (RM - rRF )bi
    Stand-alone risk = Market risk
    + Diversifiable risk
     Market risk is that part of a security’s
    stand-alone risk that cannot be
    eliminated by diversification.
     Firm-specific, or diversifiable, risk is that
    part of a security’s stand-alone risk that
    can be eliminated by diversification.

    17
    Conclusions
     As more stocks are added, each new stock
    has a smaller risk-reducing impact on the
    portfolio.
     By forming well-diversified portfolios,
    investors can eliminate about half the risk of
    owning a single stock.

    18
    Capital Asset Pricing Model
     R=Rf +Beta (Rm-Rf)

     Beta- The measure of the riskiness of


    the security

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