Chapter 12

Chapter 12 - Learning Objectives Studying some topics will...

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Unformatted text preview: Learning Objectives Studying some topics will yield an expected reward. For example, make sure you know: 1. The difference between expected and unexpected returns. 2. The difference between systematic risk and unsystematic risk. 3. The security market line and the capital asset pricing model. 4. The importance of beta. 12-1 12-2 Return, Risk, and the Security Market Line • Our goal in this chapter is to define risk more precisely, and discuss how to measure it. • In addition, we will quantify the relation between risk and return in financial markets. 12-3 Expected and Unexpected Returns • The return on any stock traded in a financial market is composed of two parts. – The normal, or expected, part of the return is the return that investors predict or expect. – The uncertain, or risky, part of the return comes from unexpected information revealed during the year. E(R)- R U Return Expected- Return Total Return Unexpected Return d Unexpecte Return Expected Return Total = = + = 12-4 Announcements and News • Firms make periodic announcements about events that may significantly impact the profits of the firm. • The impact of an announcement depends on how much of the announcement represents new information. – When the situation is not as bad as previously thought, what seems to be bad news is actually good news . – When the situation is not as good as previously thought, what seems to be good news is actually bad news . 12-5 Announcements and News • News about the future is what really matters. – Market participants factor predictions about the future into the expected part of the stock return. Announcement = Expected News + Surprise News 12-6 Systematic and Unsystematic Risk • Systematic risk is risk that influences a large number of assets. Also called market risk . • Unsystematic risk is risk that influences a single company or a small group of companies. Also called unique risk or firm-specific risk . Total risk = Systematic risk + Unsystematic risk 12-7 Systematic and Unsystematic Components of Return Expected Expected Return E(R) News Unexpected/ Unexpeced Return U Surprises (Risk) R – E(R) = U U = Systematic portion+ Unsystematic portion U = m + ε R – E(R) = m + ε 12-8 Diversification and Risk • In a large portfolio: – Some stocks will go up in value because of positive company- specific events, while – Others will go down in value because of negative company- specific events....
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This note was uploaded on 11/18/2011 for the course FIN 355 taught by Professor Phsiao during the Fall '08 term at S.F. State.

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Chapter 12 - Learning Objectives Studying some topics will...

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