lecture9-350

lecture9-350 - Risk returns and WACC CAPM and the capital...

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FIN 350: lecture 9 Risk, returns and WACC CAPM and the capital budgeting
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FIN 350: lecture 9 Today’s plan Review what we have learned in the last lecture CAPM and the expected return The security market line The application of CAPM in capital budgeting WACC
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FIN 350: lecture 9 What have we learned in the last lecture? How to measure investment performance? Total investment profit One dollar investment profit (the rate of return) How to measure risk? Variance or standard deviation Two kinds of risk Firm-level risk (unique risk, diversifiable risk, idiosyncratic risk) Systematic risk ( market risk) Risk premium Portfolio What is a portfolio? How to calculate portfolio weights? How to calculate the expected rate of return of a portfolio? Why firm-level risk can be diversified away? How to calculate the Beta of a portfolio?
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FIN 350: lecture 9 Some true or false questions 1.A market index is used to measure performance of a broad-based portfolio of stocks. 2. Long-term corporate bonds are riskier than common stocks. 3.If one portfolio's variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio. 4. Portfolio weights are always positive.
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FIN 350: lecture 9 Some true or false questions 5. Standard deviation can be calculated as the square of the variance. 6. Market risk can be eliminated in a stock portfolio through diversification. 7. Macro risks are faced by all common stock investors. 8. The risk that remains in a stock portfolio after efforts to diversify is known as unique risk. 9. We use the standard deviation of future stock prices to measure the risk of a stock.
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FIN 350: lecture 9 Measuring Market Risk Market Portfolio It is a portfolio of all assets in the economy. In practice a broad stock market index, such as the S&P 500 is used to represent the market portfolio. The market return is denoted by R m Beta ( β ) Sensitivity of a stock’s return to the return on the market portfolio, Mathematically, ) ( ) , ( m m i i R Var R r Cov = β
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FIN 350: lecture 9 An intuitive example for Beta Turbo Charged Seafood has the following % returns on its stock, relative to the listed changes in the % return on the market portfolio. The beta of Turbo Charged Seafood can be derived from this information.
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FIN 350: lecture 9 Measuring Market Risk (example, continue) Month Market Return % Turbo Return % 1 + 1 + 0.8 2 + 1 + 1.8 3 + 1 - 0.2 4 - 1 - 1.8 5 - 1 + 0.2 6 - 1 - 0.8
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FIN 350: lecture 9 Measuring Market Risk (continue) When the market was up 1%, Turbo average % change was +0.8% When the market was down 1%, Turbo average % change was -0.8% The average change of 1.6 % (-0.8 to 0.8) divided by the 2% (-1.0 to 1.0) change in the market produces a beta of 0.8. β=1.6/2=0.8
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FIN 350: lecture 9 Another example Suppose we have following information: State Market Stock A Stock B bad good -8% -10% 38%
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lecture9-350 - Risk returns and WACC CAPM and the capital...

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