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Economics
Finance
BA 323: Chapter 11
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Terms in this set (62)
Beta
Amount of systematic risk present in a particular risky asset relative to that in an average risky asset.
more
Assets with larger betas have
more/less
systematic risk.
The investor who buys Apple → Because assets with larger betas have greater systematic risk, they will have greater expected returns.
Example: An investor buys stock in Ford, with a beta of .85. Another investor buys stock in Apple, with beta of 1.15. If the market has a beta of 1.0, which investor should expect to make more?
probabilities
Expected returns are based on the ______ of possible outcomes.
0 (a risk-free asset, by definition, has no systematic risk or unsystematic risk, so a risk-free asset has a beta of 0)
A risk-free asset has a beta of...
1.0
1.5
0.8
0
0.5
14.5
=7 + 1.5 x (12-7)
=7 + 1.5 x (5)
=7 + 7.5
=14.5
Example:
Risk-free rate = 7%
Beta = 1.5
Market Return = 12%
What is the expected return?
20%
(.50 x 30%) + (.50 x 10%) = 20%
Example: There is a 0.5 percent chance of a recession occurring, and a 0.5 percent chance of a boom occurring. Stock U has a return of 30% during a recession, and a return of 10% during a boom. What is the expected return?
25%
(.50 x -20%) + (.50 x 70%) = 25%
Example: There is a 0.5 percent chance of a recession occurring, and a 0.5 percent chance of a boom occurring. Stock L has a return of -20% during a recession, and a return of 70% during a boom. What is the expected return?
zero → because this means you'll get exactly what you expect
What would be the ideal standard deviation for a portfolio?
negatively related (because they are not going in the same direction at the same time)
If you have 2 stocks in your portfolio, what kind of relationship is the most desirable?
a) positively related
b) negatively related
c) no relationship
Stock B (lower standard deviation → less risk)
Example: You have 2 portfolios that can both make a 10% return. Stock A has a standard deviation of 9%. Stock B has a standard deviation of 7%. Which portfolio would you choose?
False: You should choose the one with the
lower
standard deviation because that entails lower risk.
True/False: If two or more assets have the same expected return, you should choose the one with the higher standard deviation.
Stock A (→ If two stocks have the same amount of indigestion, always take the one with the higher return rate)
If Stock A and Stock B both have the same amount of indigestion (risk), but Stock A has a return of 12% and Stock B has a return of 10%. Which stock should you choose?
Lower (→ less risk)
Lower/Higher
variance and standard deviation is better.
Coefficient of Variance (→ whichever stock has a lower value should be chosen)
When two stocks, Stock A and Stock B, have different returns & risk levels, deciding which is better is not so clear. In a scenario like this, what would we use to determine which stock is better?
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