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Unformatted text preview: Ch. 13 Ch. Return, Risk, and the Security Return, Market Line Market Chapter Outline Chapter Expected Returns and Variances Portfolios Announcements, Surprises, and Expected Returns Risk: Systematic and Unsystematic Diversification and Portfolio Risk Systematic Risk and Beta The Security Market Line The SML and the Cost of Capital: A Preview Expected Returns Expected Expected returns are based on the probabilities Expected of possible outcomes of In this context, “expected” means average if In the process is repeated many times the E ( R ) = ∑ pi Ri i =1 n Example: Expected Returns Example: Suppose you have predicted the following Suppose returns for stocks C and T in three possible states of nature. What are the expected returns? states State Boom Normal Recession Probability 0.3 0.5 ??? C 15 10 2 T 25 20 1 RC = .3(15) + .5(10) + .2(2) = 9.9% RT = .3(25) + .5(20) + .2(1) = 17.7% Variance and Standard Deviation Deviation Variance and standard deviation measure Variance the volatility of returns the Using probabilities for the entire range of Using possibilities possibilities Weighted average of squared deviations σ 2 = ∑ pi ( Ri − E ( R)) 2 i =1 n Example: Variance and Standard Deviation Deviation Consider the previous example. What are the variance Consider and standard deviation for each stock? and Stock C σ 2 = .3(...
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This note was uploaded on 04/13/2010 for the course BUSINESS engl 102 taught by Professor Seyhanözmenek during the Spring '10 term at Middle East Technical University.

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