BA 103 Lec 5

BA 103 Lec 5 - UGBA 103: Introduction to Finance Lecture 5...

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UGBA 103: Introduction to Finance Lecture 5 (2/11/08) Risk Premium Risk affects prices of securities Expected return should be higher when prices are lower Total expected return on security riskless Risk premium = additional return you’re expecting because you’re willing to take a risk Risk —not being sure about what’s going to happen Variance associated with risk J = security, E(R j ) = expected return of security Some Answers: A Look Ahead (1) The social level of risk aversion Higher risk aversion in society, higher people will ask for taking on risk (2) Level of “variance” Realized return = actual return Higher variance securities have higher expected returns (3) Correlation with aggregate economic welfare (If calculate PV, need to discount by expected returns in future. If cash flows risky, have theory about how those should be discounted back into PV) EX. Securities Financial economists believe stock market as a whole tells you how economy is doing. (1) A stock which had high return when economy is well, low when economy is bad (ex. Toys). Returns on toy industry stock highly correlated to economy. Cyclical Returns of toy security, ex. Toys R Us probably has high returns when stock market is high (magnification factor, if stocks increases 1% toy stock might increase 2%) (2) Gold stocks are least sensitive of all industries to movement of stock market as whole. People see gold as way to store wealth so if economy bad, people buy more gold stocks. Counter-cyclical Less risky because provides security when goes down insurance Typical investor owns lots of stocks, would they rather add stock that goes up when everything else does, or goes up when everything goes
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BA 103 Lec 5 - UGBA 103: Introduction to Finance Lecture 5...

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