CHAPTER 4Risk and Return: The Basics

11/18/97

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Table of Contents

CHAPTER 4Risk and Return: The Basics

What is investment risk?

Investment Alternatives(Given in the Mini Case)

Why is the T-bill return independent of the economy?

Do T-bills promise acompletely risk-free return?

Do the returns of High Tech and Collections move with or counter to the economy?

Calculate the expected rate ofreturn on each alternative

What’s the standard deviationof returns for each alternative?

Expected Returns vs. Risk

Coefficient of Variation (CV)

Portfolio Risk and Return

Portfolio Return, kp

Alternative Method

General Statements About Risk

Returns Distribution for Two Perfectly Negatively Correlated Stocks (r = -1.0) and for Portfolio WM

Returns Distributions for Two Perfectly Positively Correlated Stocks (r = +1.0) and for Portfolio MM’

What would happen to theriskiness of an average 1-stockportfolio as more randomlyselected stocks were added?

Stand-alone Market Firm-specific

How are betas calculated?

Can a beta be negative?

Use the SML to calculate the required returns.

Required Rates of Return

Expected vs. Required Returns

Calculate beta for a portfolio with 50% HT and 50% Collections

The required return on the HT/Coll. portfolio is:

If investors raise inflationexpectations by 3 percentage points, what would happen to the SML?

If inflation did not change but risk aversion increased enough to cause the market risk premium to increase by 3 percentage points, what would happen to the SML?

Has the CAPM been verified through empirical tests?