07B Fin 301 Risk and return II

07B Fin 301 Risk and return II - Risk and Return II What Is...

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1 Risk and Return II 2 What Is the Market Portfolio? An asset’s contribution to a portfolio’s risk depends on its covariance with other asset’s in the portfolio Ultimate diversification: invest a fraction of your wealth in each available asset (in the entire world), i.e. hold the entire “market” Use market value weights: i.e. large weight on Microsoft and small weight on small firms Theory: market portfolio = collection of all available assets Practice: use TSE or S&P500 stock index 3 Risk 2 2 2 2 i M i i Systematic Idiosyncratic
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2 4 Estimating Beta + + Return On Share Return On Market + = 0.4 + + + ++ + + + + + + + + + + + + + + + + + + + + Return On Share Return On Market + = 1.6 + + + + + + + + + + + + + + + + + + + + + + + + + + + it mt i it R R 5 Market Risk Beta measures units of risk with respect to the market portfolio M i M i M M i i R R COV , 2 ) , ( 6 Portfolio Theory: Lessons and Assumptions We assume that investors in general are rational and risk-averse Investors can and will reduce risk by holding a diversified portfolio Total risk = market risk + firm-specific risk Firm-specific risk is diversifiable Market risk isn’t
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This note was uploaded on 11/01/2011 for the course BUSINESS FIN301 taught by Professor Andrew during the Fall '10 term at University of Alberta.

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07B Fin 301 Risk and return II - Risk and Return II What Is...

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