{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Lecture12_student

Lecture12_student - MoreonCAPM andrisk CAPM WhatisCAPM...

Info icon This preview shows pages 1–12. Sign up to view the full content.

View Full Document Right Arrow Icon
    More on CAPM The math behind diversification  and risk
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
CAPM The last lecture and today’s deal with CAPM What is CAPM? Capital Asset Pricing Model Wikipedia defines it as a model that “is used to  determine a theoretically appropriate required rate  of return of an asset, if that asset is to be added to  an already well-diversified portfolio, given that  asset's non-diversifiable risk” Today, we address how we derive CAPM
Image of page 2
Recall stock portfolios Stock portfolios have two or more  stocks In many examples, we will only have  two stocks Calculations become more cumbersome  with three or more stocks
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
The math Throughout the quarter, I typically have  gone through examples that are  different from the textbook Today, I will go through a complicated  example in the book Supertech and Slowpoke
Image of page 4
Supertech and Slowpoke Supertech Returns closely  follow what the  market does When times are very  good, the stock gets  a very high return When times are very  bad, the stock loses  money Slowpoke Returns do not  coincide with the  market as a whole This stock does well  in times of recession During normal times,  this stock loses  money
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Expected returns under  different market conditions Supertech  Returns (R AT ) Slowpoke  Returns (R BT ) Depression –20%  5% Recession 10% 20% Normal 30% –12% Boom 50% 9%
Image of page 6
Simple case here We assume that each state of the world  occurs with equal probability This will make the calculations easier to  do in this first example In reality, the distributions are typically  not such that each outcome occurs with  equal probability
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Calculating standard deviation  of a stock’s returns There are five steps involved in calculating the  standard deviation of the returns of each stock Step 1: Calculate the expected return of the stock Step 2: Find the difference between expected  return and actual return for the stock Step 3: Take the square of each number Step 4: Calculate the average squared deviation  (this is variance) Step 5: Take the square root of the variance
Image of page 8
Step 1: Calculate the  expected return of the stock Supertech (–0.2 + 0.1 + 0.3 + 0.5) / 4 = 0.175 = 17.5% Slowpoke (0.05 + 0.2 – 0.12 + 0.09) / 4 = 0.055 = 5.5%
Image of page 9

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Step 2: Difference between  expected return and actual return  Supertech Depression: –0.2 – 0.175 = –0.375 Recession: 0.1 – 0.175 = –0.075 Normal: 0.3 – 0.175 = 0.125 Boom: 0.5 – 0.175 = 0.325 Slowpoke Depression: 0.05 – 0.055 = –0.005 Recession: 0.20 – 0.055 = 0.145 Normal: –0.12 – 0.055 = –0.175 Boom: 0.09 – 0.055 = 0.035
Image of page 10
Step 3: Take the square of  each number Supertech Depression: –0.375 
Image of page 11

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 12
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern