How should the historical data affect decision making

Start from no risk and build up from that start with

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Unformatted text preview: verage forecast return Remember, this is where human emotion can affect stock values by “shading” what is expected (if you are more correct than market, you will time and time again overperform the market) Efficient market theory: on average, you can outperform the market Risk premium = expected return – risk free rate What kind of risks are we bearing if we’re buying a stock: history shows you get compensated for default risk and equity risk, so how much should we be compensated. Start from no risk and build up from that Start with 90- day treasury bill. We have 80 years of data that shows that we have equity premium at 7 or 8% average equities as measured by S&P 500 relative to risk- free rate. Next insight that is key to capital asset pricing model, two types of risk: Aggregate risk: measured by variance: shows how a stock moves around in total, caused by: All stocks/market is moving around because of a lot of macro factors (how china is doing, how Cyprus is doing) (SYSTEMATIC RISK) Company factors: whether intel’s next chip is going to work look at individual financial statements Both incorporated into variance of company’s stock Portfolio Return and variance: Expected portfolio return is just the weighted average of individual securities’ expected returns...
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This document was uploaded on 03/27/2014 for the course FINC 150 at Georgetown.

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