Topic 4 - Topic4:Commonstock: Analysis&Strategy...

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Topic 4: Common stock:  Required Rate of Return Passive stock strategies Active stock Strategies Approaches to stock selection
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Impact of the Market Pervasive and dominant The single most important risk affecting  the price movement of common stocks Particularly true for a diversified portfolio of  stocks  Accounts for 90% of the variability in a  diversified portfolio’s return Investors buying foreign stocks face the  same situation
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Required Rate of Return Minimum expected rate of return  needed to induce investment Given risk, a security must offer some  minimum expected return to persuade  purchase Required RoR = RF + Risk premium Investors expect the risk free rate as well  as a risk premium to compensate for the  additional risk assumed
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Understanding the Required Rate of  return Risk-free rate RF =Real RoR +Inflation premium Real rate of return is basic exchange rate  in the economy Nominal RF must contain premium for  expected inflation The risk premium  Reflects all uncertainty in the asset 
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Passive Stock Strategies Natural outcome of a belief in efficient  markets  No active strategy should be able to beat  the market on a risk adjusted basis Emphasis is on minimizing transaction  costs and time spent in managing the  portfolio Expected benefits from active trading or  analysis less than the costs
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Passive Stock Strategies Buy-and-hold strategy Belief that active management will incur  transaction costs and involve inevitable 
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Topic 4 - Topic4:Commonstock: Analysis&Strategy...

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