Documenti di Didattica
Documenti di Professioni
Documenti di Cultura
of Return
Chapter 6: Objectives
Conceptually:
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
krf
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
krf
Interest Rates
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
krf
Real
risk-free
Interest
Rate
k*
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
krf
Real
risk-free
Interest
Rate
k*
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
krf
Real
risk-free
Interest
Rate
k*
Inflationrisk
premium
IRP
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
Real
risk-free
Interest
Rate
krf
Mathematically:
k*
Inflationrisk
premium
IRP
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
Real
risk-free
Interest
Rate
krf
k*
Inflationrisk
premium
IRP
Mathematically:
Interest Rates
Conceptually:
Nominal
risk-free
Interest
Rate
Real
risk-free
Interest
Rate
krf
k*
Inflationrisk
premium
IRP
Mathematically:
Interest Rates
Suppose the real rate is 3%, and the nominal
rate is 8%. What is the inflation rate
premium?
yield
to
maturity
yield
to
maturity
Risk-free
rate of
return
Risk-free
rate of
return
Risk-free
rate of
return
Risk
premium
Returns
Expected Return
State of Probability
Return
Economy
(P)
Orl. Utility Orl. Tech
Recession
.20
4%
-10%
Normal
.50
10%
14%
Boom
.30
14%
30%
For each firm, the expected return on the
stock is just a weighted average:
Expected Return
State of Probability
Return
Economy
(P)
Orl. Utility Orl. Tech
Recession
.20
4%
-10%
Normal
.50
10%
14%
Boom
.30
14%
30%
For each firm, the expected return on the
stock is just a weighted average:
k = P(k1)*k1 + P(k2)*k2 + ...+ P(kn)*kn
Expected Return
State of Probability
Return
Economy
(P)
Orl. Utility Orl. Tech
Recession
.20
4%
-10%
Normal
.50
10%
14%
Boom
.30
14%
30%
k = P(k1)*k1 + P(k2)*k2 + ...+ P(kn)*kn
k (OU) = .2 (4%) + .5 (10%) + .3 (14%) = 10%
Expected Return
State of Probability
Return
Economy
(P)
Orl. Utility Orl. Tech
Recession
.20
4%
-10%
Normal
.50
10%
14%
Boom
.30
14%
30%
k = P(k1)*k1 + P(k2)*k2 + ...+ P(kn)*kn
k (OI) = .2 (-10%)+ .5 (14%) + .3 (30%) = 14%
RISK?
What is Risk?
The possibility that an actual return
will differ from our expected return.
What is Risk?
Uncertainty in the distribution of
possible outcomes.
What is Risk?
Uncertainty in the distribution of
possible outcomes.
Company A
return
What is Risk?
Uncertainty in the distribution of
possible outcomes.
Company A
Company B
return
return
Standard Deviation
i=1
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
P(ki)
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) = 7.2
(( 4%
10%)
4% - 10%) (.2) = 7.2
P(ki)
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) =
(( 4%
10%)
4% - 10%) (.2) =
(10%
(10% -- 10%)
10%)22 (.5)
(.5) ==
7.2
7.2
00
P(ki)
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) =
(( 4%
10%)
4% - 10%) (.2) =
(10%
(10% -- 10%)
10%)22 (.5)
(.5) ==
(14%
(14% -- 10%)
10%)22 (.3)
(.3) ==
7.2
7.2
00
4.8
4.8
P(ki)
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) =
(( 4%
10%)
4% - 10%) (.2) =
(10%
(10% -- 10%)
10%)22 (.5)
(.5) ==
(14%
(14% -- 10%)
10%)22 (.3)
(.3) ==
Variance
==
Variance
7.2
7.2
00
4.8
4.8
12
12
P(ki)
(ki - k)
i=1
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) = 7.2
(( 4%
10%)
4% - 10%) (.2) = 7.2
(10%
(10% -- 10%)
10%)22 (.5)
(.5) == 00
(14%
(14% -- 10%)
10%)22 (.3)
(.3) == 4.8
4.8
Variance
==
12
Variance
12
Stand.
Stand. dev.
dev. == 12
12 ==
P(ki)
(ki - k)
i=1
P(ki)
Orlando
Orlando Utility,
Utility, Inc.
Inc.
22 (.2) = 7.2
(( 4%
10%)
4% - 10%) (.2) = 7.2
(10%
(10% -- 10%)
10%)22 (.5)
(.5) == 00
(14%
(14% -- 10%)
10%)22 (.3)
(.3) == 4.8
4.8
Variance
==
12
Variance
12
Stand.
Stand. dev.
dev. == 12
12 == 3.46%
3.46%
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
(ki - k)
i=1
P(ki)
Summary
Orlando
Utility
Expected Return
Standard Deviation
Orlando
Technology
10%
14%
3.46%
13.86%
Risk
Risk
Portfolios
time
kA
rate
of
return
time
kA
rate
of
return
kB
time
kA
rate
of
return
kB
time
kA
rate
of
return
kB
time
kp
Diversification
Investing in more than one security to
reduce risk.
If two stocks are perfectly positively
correlated, diversification has no
effect on risk.
If two stocks are perfectly negatively
correlated, the portfolio is perfectly
diversified.
Market Risk
Company-unique Risk
number of stocks
Market risk
number of stocks
Market risk
number of stocks
Note
As we know, the market compensates
investors for accepting risk - but
only for market risk. Companyunique risk can and should be
diversified away.
So - we need to be able to measure
market risk.
Calculating Beta
Calculating Beta
XYZ Co. returns
15
10
S&P 500
returns
5
-15
-10
-5 -5
-10
-15
10
15
Calculating Beta
XYZ Co. returns
15
S&P 500
returns
-15
.. .
.
.
.
.
10 . . . .
.. . .
. . 5. .
.. . .
.
.
.
.
-10
5
-5 -5
10
.. . .
. . . . -10
.. . .
. . . -15.
15
Calculating Beta
XYZ Co. returns
15
S&P 500
returns
-15
.. .
.
.
.
.
10 . . . .
.. . .
. . 5. .
.. . .
.
.
.
.
-10
5
-5 -5
10
.. . .
. . . . -10
.. . .
. . . -15.
15
Calculating Beta
XYZ Co. returns
15
S&P 500
returns
-15
.. .
Beta = slope
= 1.20
.
.
.
.
10 . . . .
.. . .
. . 5. .
.. . .
.
.
.
.
-10
5
-5 -5
10
.. . .
. . . . -10
.. . .
. . . -15.
15
Summary:
Required
rate of
return
Required
rate of
return
Risk-free
rate of
return
Required
rate of
return
Risk-free
rate of
return
Risk
premium
Required
rate of
return
Risk-free
rate of
return
market
risk
Risk
premium
Required
rate of
return
Risk-free
rate of
return
market
risk
Risk
premium
companyunique risk
Required
rate of
return
Risk-free
rate of
return
market
risk
Risk
premium
companyunique risk
can be diversified
away
Required
rate of
return
Beta
Required
rate of
return
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
12%
security
market
line
(SML)
Beta
Risk-free
rate of
return
(6%)
Required
rate of
return
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
Is there a riskless
(zero beta) security?
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
Is there a riskless
(zero beta) security?
12%
Risk-free
rate of
return
(6%)
SML
Treasury
securities are
as close to riskless
as possible.
Beta
Required
rate of
return
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
12%
Risk-free
rate of
return
(6%)
SML
Required
rate of
return
SML
Utility
Stocks
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
High-tech
stocks
SML
12%
Risk-free
rate of
return
(6%)
Beta
Example:
Required
rate of
return
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
Theoretically, every
security should lie
on the SML
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
Theoretically, every
security should lie
on the SML
SML
12%
If every stock
is on the SML,
investors are being fully
compensated for risk.
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
If a security is above
the SML, it is
underpriced.
SML
12%
Risk-free
rate of
return
(6%)
Beta
Required
rate of
return
If a security is above
the SML, it is
underpriced.
SML
12%
If a security is
below the SML, it
is overpriced.
Risk-free
rate of
return
(6%)
Beta
$60
t+1
$60
t+1
Pt+1 - Pt
Pt
60 - 50
50
= 20%
$60
t+1
Pt+1 - Pt
Pt
Pt+1
Pt
-1 =
60 - 50
50
60
50
= 20%
-1 = 20%
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
0.096
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
0.096
0.075
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
0.096
0.075
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
(a - b)2
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
0.096
0.075
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
(a - b)2
0.012321
0.002601
0.015376
0.000004
0.000081
0.000441
0.002401
0.001444
0.002601
0.028960
0.002090
0.000676
month
Dec
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
price
$50.00
$58.00
$63.80
$59.00
$62.00
$64.50
$69.00
$69.00
$75.00
$82.50
$73.00
$80.00
$86.00
(a)
(b)
monthly expected
return
return
0.160
0.100
-0.075
0.051
0.040
0.070
0.000
0.087
0.100
-0.115
0.096
0.075
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
0.049
(a - b)2
0.012321
0.002601
0.015376
0.000004
0.000081
0.000441
0.002401
0.001444
0.002601
0.028960
0.002090
0.000676
0.0781