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Kd, Kps, Kce CAPM, APT and FF 3-Factor Model WACC

2. . . . Types of long-term capital . Long-term debtPreferred stockCommon equity. 3. . . . Terminologies. Expected Rate of Return: Investors' return based on the actual market price.Required Rate of Return: Investors' return that can perfectly compensates for the risk that they takes. Co

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Kd, Kps, Kce CAPM, APT and FF 3-Factor Model WACC

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    1. 1 Kd, Kps, Kce CAPM, APT and FF 3-Factor Model WACC

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    22. 22 Assume the Following Investment Alternatives

    23. 23 Calculate the expected rate of return on each alternative.

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    25. 25 What is the standard deviation of returns for each alternative?

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    27. 27 Expected Return versus Risk

    28. 28 Two-Stock Portfolios Two stocks can be combined to form a riskless portfolio if r = -1.0. Risk is not reduced at all if the two stocks have r = +1.0. In general, stocks have r ? 0.65, so risk is lowered but not eliminated. Investors typically hold many stocks. What happens when r = 0?

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    31. 31 Market Risk vs. Firm Risk

    32. 32 Market risk, which is relevant for stocks held in well-diversified portfolios, is defined as the contribution of a security to the overall riskiness of the portfolio. It is measured by a stock’s beta coefficient, which measures the stock’s volatility relative to the market. What is the relevant risk for a stock held in isolation?

    33. 33 How are betas calculated? Run a regression with returns on the stock in question plotted on the Y axis and returns on the market portfolio plotted on the X axis. The slope of the regression line, which measures relative volatility, is defined as the stock’s beta coefficient, or b.

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    36. 36 If b = 1.0, stock has average risk. If b > 1.0, stock is riskier than average. If b < 1.0, stock is less risky than average. Most stocks have betas in the range of 0.5 to 1.5. Can a stock have a negative beta? How is beta interpreted?

    37. 37 Expected Return versus Market Risk

    38. 38 Use the SML to calculate each alternative’s required return. The Security Market Line (SML) is part of the Capital Asset Pricing Model (CAPM). SML: ki = kRF + (RPM)bi .

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    40. 40 Required Rates of Return

    41. 41 Expected versus Required Returns

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