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# Ch 13 - Ch 13 Return Risk and Security Market Line(SML 1...

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Ch 13. Return, Risk and Security Market Line (SML)

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1. Expected Returns and Variance Until now, we mainly concerned historical returns and risks. However, in this chapter, we will cover returns and variance in future. Without estimating returns and variance in future, we can not make decisions. 1) Expected return = - × = T i i i R E P R E 1 ) ( ) (
Ex) E(R L ) = 0.6×(-0.2)+0.4×0.7 = 0.16 E(Ru) = 0.6×(0.3)+0.4×0.1 = 0.22 If a risk free rate is 8%, then risk premium is 0.08 and 0.14, respectively. State of Economy Probability Stock L Stock U Recession 0.6 -20% 30% Boon 0.4 70% 10% Sum 1

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2) (Expected) Variance Ex) in the previous example, Var(L) = 0.6*(-0.2-0.16)^2+0.4*(0.7-0.16)^2 = 0.1944 and STDEV(L) = 0.4409. Var(U) = 0.6*(0.3-0.22)^2+0.4*(0.1-0.22)^2 = 0.0096 and STDEV(U) = 0.09798. Which one do you want to buy? 2 1 )] ( ) ( [ ) ( = - - × = T i i i R E R E P R Var
3) Portfolios: group of stocks, bonds or investments. Portfolio Weight: percentage of total

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Ch 13 - Ch 13 Return Risk and Security Market Line(SML 1...

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