FIN351_Chapter12

FIN351_Chapter12 - 1 Chapter 12 Risk, Return, and Capital...

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Unformatted text preview: 1 Chapter 12 Risk, Return, and Capital Budgeting CAPM and the Capital Budgeting 2 Topics Covered Measuring Market Risk Beta Risk and Return CAPM Capital Budgeting and Project Risk 3 Measuring Market Risk Market Portfolio- Portfolio of all assets in the economy. In practice a broad stock market index is used to represent the market. Beta- Sensitivity of a stocks return to the return on the market portfolio. ) ( ) , ( m m i i R Var R r Cov = 4 Measuring Market Risk Beta > 1: stock returns respond more than one for one to changes in the return of the overall market. (Aggressive Stocks) Beta < 1: stock returns vary less than one for one with market returns. (Defensive Stocks) The average beta of all stocks is 1.0 5 Measuring Market Risk Example- 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. 6 Measuring Market Risk Example- continued 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 Average = 0.8% Average = -0.8% 7 Measuring Market Risk Example- continued 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....
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FIN351_Chapter12 - 1 Chapter 12 Risk, Return, and Capital...

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