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Expected Return for Individual Stocks

Expected Return for Individual Stocks. Probability x Return = ___% Probability x Return = ___% Expected Return = ___. Calculating Expected Return. Expected Return. Expected Return for Portfolio. Portfolio Weight x Return = ___% Portfolio Weight x Return = ___%

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Expected Return for Individual Stocks

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  1. Expected Return for Individual Stocks • Probability x Return = ___% • Probability x Return = ___% • Expected Return = ___ Capital Markets

  2. Calculating Expected Return Expected Return Capital Markets

  3. Expected Return for Portfolio • Portfolio Weight x Return = ___% • Portfolio Weight x Return = ___% • Expected Return = ___ Capital Markets

  4. Portfolio Expected Return Capital Markets

  5. Portfolio Beta Capital Markets

  6. Standard Deviation of Portfolio • Not the average of standard deviation for portfolio components • Calculation • Calculate expected return for portfolio under each condition • Then determine deviation from expected return from portfolio, square it, multiply times probability, sum it, and take the square root…which sounds familiar… Capital Markets

  7. Risk • Unsystematic: impacts a single stock or industry • Dole recalls spinach • Systematic: impacts most, if not all, stocks • Fed leaves interest rates unchanged Capital Markets

  8. Diversification • Create a portfolio of 20 stocks with a low correlation: chart on Page 338 • This would eliminate almost all unsystematic risk • Unsystematic risk is not rewarded • Investing 90% of your portfolio in one stock • Low correlation: stocks that don’t tend to move in the same direction • Airline and oil stocks, for example Capital Markets

  9. CAPM and SML • SML: reflects risk-reward ratio for an individual security • Risk is measured by beta • Assumes security is in a diversified portfolio • How much risk does a security add to a diversified portfolio? Capital Markets

  10. CAPM • ER = RF + (MR – RF) x B • RF = “Risk-free” rate of return on T-bills • Currently __% • MR = Expected Return for the Market • Approximately 12% for large-cap stocks • B = Beta What happens to Expected Return if the Market has additional risk? If the asset’s beta increases? Capital Markets

  11. Beta • Measures systematic risk • Not total risk since it doesn’t include unsystematic risk • Market = 1.0 • Can beta be negative? • Can betas be different if you look at different sources? • Generally based on 5-year moving average Capital Markets

  12. CAPM Capital Markets

  13. Coefficient of variation Capital Markets

  14. Reward/Risk Relationship • Coefficient of variation = Reward / Risk • = Expected return / Standard deviation or Beta • Textbook: Reward-to-risk ratio • In an efficient market, should be the same for all assets Capital Markets

  15. News and Expected Returns • Surprise news: impacts stock price • MSFT earnings are below estimates • Inflation is higher than expected • What the market already knows is discounted into current stock price Capital Markets

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