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ch 13 (Risk Return and CAPM)

# ch 13 (Risk Return and CAPM) - Key Concepts and Skills Know...

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Chapter 13 Return, Risk, and the Security Market Line Slide 13 - 1 Key Concepts and Skills Know how to calculate expected returns and variance for individual asset and for portfolios Understand systematic and unsystematic risks and the effect of diversification Understand the risk-return trade off Be able to use the Capital Asset Pricing Model Slide 13 - 2 Expected Returns Calculating the Expected Return The expected return, denoted as E(R), is the return investors expected on a risky asset in the future . It is based on the probabilities of possible return outcomes: In this context, “expected” means average if the process is repeated many times. The “expected” return does not even have to be a possible return. = = n i i i R p R E 1 ) ( Slide 13 - 3 Expected Returns Example You have predicted the following returns for stocks C and T in three possible states of nature. What are the expected returns? State Probability C T Boom 0.3 15% 25% Normal 0.5 10% 20% Recession ? 2% 1% E(R C ) = .3(15) + .5(10) + .2(2) = 9.9% E(R T ) = .3(25) + .5(20) + .2(1) = 17.7%

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