FINC 341 Chp 8 notes

FINC 341 Chp 8 notes - StandAloneRisk o o Risk:ahazard;aperil; (1)onastandalonebasis ,and(2)onaportfoliobasis,wherethe

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Finance 341 Chapter 8 Notes Stand-Alone Risk o Risk : “a hazard; a peril; exposure to loss or injury.” o An asset’s risk can be analyzed in two ways : (1) on a stand-alone basis,  where the asset is considered by itself, and (2) on a portfolio basis, where the  asset is held as one of a number of assets in a portfolio o Stand-Alone Risk : the risk an investor would face if he or she held only one  asset o No investment should be undertaken unless the expected rate of return is high  enough to compensate for the perceived risk.   o Statistical Measures of Stand-Alone Risk : Probability Distributions : a listing of possible outcomes or events with a  probability (chance of occurrence) assigned to each outcome The tighter the probability distribution, the lower the risk The tighter the probability distribution of expected future returns,  the smaller the risk of a given investment Expected Rate of Return : the rate of return expected to be realized from  an investment; the weighted average of the probability distribution of  possible results Standard Deviation : a measure of how far the actual return is likely to  deviate from the expected return Coefficient of Variation : the standardized measure of the risk per unit of  return; calculated as the standard deviation divided by the expected  return. Risk   Aversion :  risk-averse investors dislike risk and require higher rates  of return as an inducement to buy riskier securities
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Q:  What are the implications of risk aversion for security prices  and rates of return? A:  other things held constant, the higher a security’s risk, the  higher its required return; and if this situation does not hold, prices  will change to bring about the required condition Risk Premium : the difference between the expected rate of return on a  given risky asset and that on a less risky asset 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. o
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This note was uploaded on 11/04/2009 for the course FINC 341 taught by Professor Guyton during the Spring '07 term at Texas A&M.

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FINC 341 Chp 8 notes - StandAloneRisk o o Risk:ahazard;aperil; (1)onastandalonebasis ,and(2)onaportfoliobasis,wherethe

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