Professional Documents
Culture Documents
Corporate Finance
Dr. A. DeMaskey
Learning Objectives
Questions to be answered:
What is risk?
How is risk measured?
What is the relationship between risk and
return?
Dollar terms
Percentage terms
Probability Distribution
Stock X
Stock Y
-20
15
50
Rate of
return (%)
Standard Deviation
Coefficient of Variation
Portfolio Return, kp
Portfolio Risk, p
Covariance
Portfolio Variance
Portfolio Standard Deviation
Correlation Coefficient
Two-Stock Portfolio
Company Specific
(Diversifiable) Risk
35
Stand-Alone Risk, p
20
Market Risk
0
10
20
30
40
2,000+
# Stocks in Portfolio
Conclusion
Beta
Risk aversion
Expected
return
17.4%
15.0
13.8
8.0
1.7
Risk, b
1.29
1.00
0.68
0.00
-0.86
I = 3%
New SML
SML2
SML1
18
15
11
8
Original situation
0.5
1.0
1.5
2.0
After increase
in risk aversion
SML2
kM = 18%
kM = 15%
SML1
18
RPM =
3%
15
8
Original situation
1.0
Risk, bi
Drawbacks of CAPM
Beta is an estimate.
Unrealistic assumptions.
Not testable.
CAPM does not explain differences in
returns for securities that differ:
Over time
Dividend yield
Size effect