Relationship Between Risk and Return

Relationship Between Risk and Return - Relationship Between...

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Unformatted text preview: Relationship Between Risk and Return • The Security Market Line (SML) – – It shows the relationship between risk and return for all risky assets in the capital market at a given time. Investors select investments that are consistent with their risk preferences. ExpectedReturn Low Risk NRFR Average Risk High Risk Security Market Line The slope indicates the required return per unit of risk Risk 1-1 (business risk, etc., or systematic risk-beta) Relationship Between Risk and Return • Movement along the SML – When the risk of an investment changes due to a change in one of its risk sources, the expected return will also change, moving Expected along the SML. Return SML NRFR Movements along the curve that reflect changes in the risk of the asset Risk (business risk, etc., or systematic risk-beta) 1-2 Relationship Between Risk and Return • Changes in the Slope of the SML – – When there is a change in the attitude of investors toward risk, the slope of the SML will also change. If investors become more risk averse, then the SML will have a steeper slope, indicating Expected Return New SML a higher risk premium, RPi, for the same risk R level. m’ Original SML Rm NRFR Risk 1-3 Relationship Between Risk and Return • Changes in Market Condition or Inflation – – A change in the RRFR or the expected rate of inflation will cause a parallel shift in the SML. When nominal risk-free rate increases, the SML will shift up, implying a higher rate of Expected Return New return while still having the same risk SML premium. Original SML NRFR' NRFR 1-4 Risk The Internet Investments Online • http://www.finpipe.com • http://www.investorguide.com • http://www.aaii.com • http://www.economist.com • http://online.wsj.com • http://www.forbes.com • http://www.barrons.com • http://fisher.osu.edu/fin/journal/jofsites.htm • http://www.ft.com • http://www.fortune.com • http://www.smartmoney.com 1-5 ...
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This note was uploaded on 01/24/2012 for the course FIN 4360 taught by Professor Davidbray during the Spring '12 term at Kennesaw.

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Relationship Between Risk and Return - Relationship Between...

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