BCOR 2200 Chapter 11

# BCOR 2200 Chapter 11 - Chapter 11 Risk and Return 1 Chapter...

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1 Chapter 11 Risk and Return

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2 Chapter Overview Last chapter we looked at risk and return for classifications of stocks This chapter we look risk and return in more detail Spend more time on risk and return calculations for individual stocks Spend more time on risk and return calculations for a portfolio of stocks Specific Skills Calculate expected returns and risk Understand the impact of diversification Understand the systematic risk principle Understand the security market line Understand the risk-return trade-off
3 Chapter Outline Calculate returns and risk (variance and standard deviation) for individual stocks Calculate returns and risk for portfolios Expected Values and Actual Announced Values The difference between them is called the Surprise Announcements by companies, the government… Two components of Risk “Systematic” and “Unsystematic” How Diversification lowers Portfolio Risk Measuring Systematic Risk with Beta The Security Market Line (SML) The SML and the Cost of Capital: A Preview

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4 Risk and Return Calculations Two ways to deal with expected values Depending on how the data is presented – We’ll consider height First Way: – We have all the data: – Get everybody’s height (measure or ask?) Calculate the mean and σ : – The Expected Height is the Mean Height Height H = ( 29 ( 29 ( 29 ( 29 ( 29 [ ] H H H H H H 1 N 1 1 N H H H Var 2 N 2 2 2 1 N 1 i 2 i 2 - + + - + - - = - - = = å = L s ( 29 2 Var(H) H SD s s = = = ( 29 + + + = = = = N R R R N H H E(H) N 2 1 N 1 i i 1 1 L
5 Risk and Return Calculations (Part 2) Second Way: Set “categories” or ranges of height Calculate mean for each category Calculate (or assign) Probabilities for each category Calculate expectation: E(H) = 66.3 inches Why might this way be better? You can change category probabilities based on new information or expectations Intramural basketball meeting, so reset probs to 10%, 10% and 80% New E(H) = 70.3 inches = = N i i i H p H E 1 ) ( Category (i) Prob ( p i ) Inches (H i ) p i H i Lowest 30% 61 18.3 Middle 40% 66 26.4 Highest 30% 72 21.6 Sum 100% 66.3

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6 Risk-Return Calculation Outline: 11.1 Single Stock 1. Return Calculations for a Single Stock E(R i ) = Expected Return of some stock i 1. Risk Calculations for a Single Stock σ i 2 (and σ i ) = Variance (and SD) of some Stock i 11.2 Portfolios 1. Return Calculations for a Portfolio E(R P ) = Expected Return of a Portfolio of stocks
7 But First Some Notation (Part 1): p s = Probability of some “state obtaining” S = The Number of possible states s = One of the states R = Return R i = Return of stock i Distinguish between stocks if we are considering more than one R S = Return given some state of the economy R S,i = Return given some state of the economy for stock i E(R) = Expected Return E(R i ) = Expected Return of stock i E(R P ) = Expected Return of a portfolio

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## This note was uploaded on 03/17/2009 for the course BCOR 2200 taught by Professor Tomnelson during the Fall '08 term at Colorado.

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BCOR 2200 Chapter 11 - Chapter 11 Risk and Return 1 Chapter...

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