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Business Administration Introduction to Portfolio Theory Basics: Present value of a perpetuity: C/r Present value of a growing (or shrinking) perpetuity: C/(r-g) Present value of C dollars t years from now: C/[(1+r) t ] Present value of a C-dollar t-year annuity: C[(1/r)-(1/[r(1+r) t ]) beta = [E((r 1 -E(r 1 ))(m-E(m))]/E[(m-E(m)) 2 ] r* i = r* f + beta i (r* m -r f ) Not happy with the lecture I gave last time; tried to do to much and gave much-too-quick explanations of important things. So let me back up a bit, and go over the "benefits of diversification" again. Benefits of Diversification "The opportunity cost of capital depends on the risk of the project": I've been saying this for three and a half weeks now. But what does it mean? What is the risk of a project? Why should

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Unformatted text preview: the appropriate cost of capital vary depending on how risky the project is? Let's start with risk. State of the World Mega Manufacturing Startup Semiconductor HH +40% +10% HT +10% -20% TH +10% +40% TT -20% +10% Expected Value. .. EV = +10% EV = +10% Standard Deviation. .. SD = 21.2% SD = 21.2% What risk-return combination do you get if you put all your money into one stock or the other? But suppose you start mixing one with the other. .. 25%M+75%S Mega Manufacturing Startup Semiconductor 17.5% +40% +10% -12.5% +10% -20% 32.5% +10% +40% 2.5% -20% +10% EV = +10% EV = +10% EV = +10% SD= 16.8% SD = 21.2% SD = 21.2% 0M+1S .25M+.75S .5M+.5S .75M+.25S 1M+0S Expected Return +10% +10% +10% +10% +10% Standard Deviation 21.2% 16.8% 15% 16.8% 21.2%...
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