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Formulas Chapter 6 (Photocopies) Lecture 9 Risks Holding-Period Dollar Gain (or Dollar Gain)= Price End of Period + Dividend + Price Beginning Period Holding-Period Rate of Return= Dollar Gain Price Beginning of Period Expected Cash flow ( X ) = Σ Pbi * Cfi ▫ Where Pbi = probabilities of outcome i CFi = cash flows in outcome i Expected Return (%) = Σ Pbi * ri ▫ Where Pi = probabilities of outcome i ki = expected % return in outcome i Monthly Holding Return=

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Portfolio Beta: bportfolio= Σ wj *b j Where wj = % invested in stock j b i = Beta of stock j Investor Required Rate of Return= Risk Defined • Risk refers to potential variability in future cash flows. • The wider the range of possible future events that can occur, the greater the risk. • The returns on common stock is more risky than returns from investing in savings account in a bank. Standard Deviation: square root of the weighted average squared deviation of each possible
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Unformatted text preview: return from the expected return. Total risk of Portfolio is due to two types of Risk: â–« Systematic (or Market risk) is risk that affects all firms (ex. Tax rate changes, war) â–« Unsystematic or company unique risk(ex. Labor strikes, CEO change) â–« If two stocks are perfectly positively correlated, diversification has no effect on risk. â–« If two stocks are perfectly negatively correlated, the portfolio is perfectly diversified. â€˘ Beta is the risk that remains for a company even after we have diversified our portfolio. â–« A stock with a Beta of 0 has no systematic risk â–« A stock with a Beta of 1 has systematic risk equal to the â€śtypicalâ€ť stock in the marketplace â–« A stock with a Beta exceeding 1 has systematic risk greater than the â€śtypicalâ€ť stock...
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