RODULFA, LYCKSELE M.

COEFFICIENT OF VARIATION
COEFFICIENT OF VARIATION

THE INVESTMENT COMMUNITY AGREES

THAT EXPECTED RETURN SHOULD
INCLUDE AS RISK INCREASES
COEFFICIENT OF VARIATION
Standard Deviation of Return
Expected Mean Return

COEFFICIENT OF
VARIATION FORMULA
COEFFICIENT OF VARIATION

THE CV PROVIDES A QUICK SUMMARY

OF THE RELATIVE-TRADE-OFF BETWEEN
EXPECTED RETURN AND RISK.
COEFFICIENT OF VARIATION
 BETA
ANOTHER MEASURE OF INVESTMENT RISK
BETA

CAPITAL ASSET PRICING MODEL

▸ Use in determining the
security’s required rate of
return.

▸ A model developed to help

determine a share’s required
rate of return for a given level
of risk.
THE STANDARD DEVIATION IS
DIFFICULT TO USE WHEN THE
STOCK IS HELD IN A
PORTFOLIO.

SYSTEMATIC RISK IS
MEASURED BY A STOCK’S
BETA COEFFICIENT.
BETA

A MEASURE OF THE SENSITIVITY OF A

SECURITY’S RETURN RELATIVE TO THE RETURNS
OF A BROAD-BASED MARKET PORTFOLIO
SECURITIES.
BETA
BETA

BETA
▸ Ratio of the covariance of returns
of security (i), and market
portfolio (m), to the variance of
returns of the market portfolio.

▸ It measures the movement of

between a stock and the market
portfolio. It is a key element of
the CAPM.
 AN ABSOLUTE STATISTICAL
MEASURE OF THE EXTENT OF
TWO VARIABLES, SUCH AS
SECURITIES MOVE
TOGETHER.

COVARIANCE
CAPITAL ASSET PRICING MODEL
A model based on the proposition that any
stock’s required rate of return is equal to
the risk free rate of return plus a risk
premium that reflects only the risk
remaining after diversification.
CAPITAL ASSET PRICING MODEL

CAPITAL ASSET PRICING MODEL

▸ General framework for
analyzing risk-return
relationships for all types of
assets.

▸ CAPM only use a part of the

total risk called systematic
risk.
DIVERSIFIABLE RISK

UNSYSTEMATIC/COMPANY RISK

UNDIVERSIFIABLE
RISK

SYSTEMATIC/MARKET RISK

MAJOR COMPONENTS OF TOTAL RISK

TEXT

PART OF A SECURITY’S RISK CAUSED BY FACTORS

UNIQUE TO A PARTICULAR FIRM. SOURCES OF
DIVERSIFIABLE RISK INCLUDE LAWSUITS, STRIKES,
COMPANY MANAGEMENT ETC.
DIVERSIFIABLE / UNSYSTEMATIC / COMPANY RISK
TEXT

PART OF A SECURITY’S RISK CAUSED BY FACTORS

AFFECTING THE MARKET AS A WHOLE. IT IS THE
ONLY RELEVANT RISK AFFECTED BY SUCH FACTORS
SUCH AS WARS, INFLATION, INTEREST RATE ETC.
UNDIVERSIFIABLE / SYSTEMATIC / MARKET RISK
Manaog Company has a beta coefficient of
1.6. The current rate of return on Treasury
securities is 9%. Analysts estimate the
return on the market portfolio to be 13%.

DETERMINATION OF THE REQUIRED RATE

OF RETURN USING THE CAPM APPROACH
WHAT RATE OF RETURN WILL AN INVESTOR REQUIRE TO
INVEST IN A RISK-FREE ASSET?
▸ 9%
WHAT COMPONENTS MAKE UP THE RISK-FREE RATE OF
RETURN?
▸ REAL RATE OF INTEREST THAT IS THE RATE OF RETURN
IT TAKES TO GET INVESTORS TO POSTPONE
CONSUMPTION PLUS AN INFLATION PREMIUM TO
PROTECT THE INVESTOR AGAINST RISING PRICE LEVELS.
 WHAT IS THE PRICE PER UNIT OF RISK OR BETA?
▸ (13% - 9%) = 4%
WHAT IS THE QUANTITY OF RISK OR BETA?
▸ 1. 6 UNITS
WHAT RATE OF RETURN WILL AN INVESTOR REQUIRE TO
INVEST IN MANAOAG COMPANY?
▸ Required Rate of Return= 9% + (13% - 9%) 1.6 

=15.4%
 WHAT ADDITIONAL RETURN DID AN INVESTOR REQUIRE TO
MOVE FROM A RISK-FREE ASSET WITH ZERO UNITS OF RISK
TO AN ASSET THAT HAS 1.6 UNITS OF RISK?
▸ Additional return
= (13% - 9%) 1.6
needed to induce an
investor to move from = (4%) 1.6
the risk free asset to an
=6.4%
asset that has 1.6 units
of risk.
 WITHOUT DOING ANY CALCULATIONS, WHAT DO YOU THINK
WOULD HAPPEN TO OUR INVESTOR’S REQUIRED RATE OF RETURN
IF THE QUANTITY OF RISK WENT FROM 1.6 UNITS TO 2.4 UNITS?
EXPLAIN YOUR LOGIC MAKING SURE TO ANSWER IN WORDS ONLY.
▸ Our investors would require a greater rate of return to
compensate for additional risk. Recall we assume that all
rational investors are risk averse. This means that
investors do not like risk and if we want an investor to
take on more risk we have to offer inducements (higher
returns).
WHAT RATE OF RETURN WOULD AN INVESTOR REQUIRE IF THE
AMOUNT OF RISK INCREASED FROM 1.6 UNITS TO 2.4 UNITS?
▸ Required rate of return = 9% + (13% - 9%) 2.4 = 18.6%