Topic 9 and 10

# Topic 9 and 10 - Topic 9 Equity Risk premium Prescribe book...

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Prescribe book Berk,J. ,Demarzo,P. and Harford,J.,2009, Fundamentals of Corporate Finance , Pearson Education, Chapter 11.
Expected Return of a Portfolio Portfolio weights Portfolio Returns: is the weighted average of the returns on the investments in the portfolio, where the weights correspond to portfolio weights. portfolio of value Total i investment of Value = i w n n p R w R w R w R + + + = .... 2 2 1 1

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Expected Return of a Portfolio Example1: Suppose you invest \$100,000 and buy 200 shares of Apple at \$200 per shares and 1000 shares of Coca- Cola at \$60 per share. If Apple’s stock goes up to \$240 per share and Coca-Cola stock falls to \$57 per share and neither paid dividends, what is the new value of the portfolio? What return did the portfolio earn? Re-calculate the return of the portfolio by calculating the individual returns of the stocks and multiplying them by their weights in the portfolio. If you don’t buy or sell after the price change, what are the new portfolio weights?
Expected Return of a Portfolio We can use the historical average return of a security as its expected return The expected return of a portfolio is simply the weighted average of the expected returns of the investments within it, using the portfolio weights: ] [ .... ] [ ] [ ] [ 2 2 1 1 n n p R E w R E w R E w R E + + + =

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Total risk of a portfolio By combining stocks into a portfolio, we reduce risk through diversification. The amount of risk that is eliminated in a portfolio depends upon the degree to which the stocks face common risks and move together.
Correlation Correlation is used to measure the degree of co-movement of stocks’ returns, ranging from -1 to +1 Independent risks are uncorrelated. Stock returns will tend to move together if they

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Topic 9 and 10 - Topic 9 Equity Risk premium Prescribe book...

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