Lec 10 Risk and Rate of Return. It's for finance

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1. Risk and Rate of Return Chapter: 08 1

2. Risk and Rate of Return Risk: The chance that some unfavorable event will occur. Expected Rate of Return, r: The rate of return expected to be realized from an investment; the weighted average of the probability distribution of possible results. 2

3. Individual Return and Portfolio Return Find out the expected Return for Martin and US Water? If you invest 40% in Martin and 60% in US Water, what will be your portfolio return? 3

4. Individual Return 4

5. Portfolio Return 5 Portfolio Return = .1 × .4 + .1 × .6 = .1 = 10%

6. Individual Risk: The Standard Deviation Find out the Standard Deviation of US Water. σ = . 0387298 6

7. Portfolio Risk What is Portfolio Risk ( σ p ), if the correlation is .50. 7

8. The Coefficient of Variation Coefficient of Variation (CV): The standardized measure of the risk per unit of return; calculated as the standard deviation divided by the expected return. Find out the CV of both Martin and US Water? 8

9. The CAPM Capital Asset Pricing Model (CAPM): A model based on the proposition that any stock’s required rate of return is equal to the risk free rate of return plus a risk premium that reflects only the risk remaining after diversification. Return = Risk free rate + Market risk Premium × Stock Beta =Risk free rate + (Market return – Risk free rate) × Stock beta 9

10. Class Summary 10