1. Portfolio Risk  In general, the riskiness of a portfolio (  portfolio ) will -  Systematic vs. Diversifiable Risk

2. Beta  Beta Defined -   Examples: FBeta = 1.0 FBeta = 0.5 FBeta = 2.0 FBeta < 0.0

3. Calculating Beta  Plot the stock’s return over time against the market’s return over time. Fit a (regression) line to the observations. The slope of the line is the firm’s estimated beta coefficient. Example #1: Given the following information, calculate the firm’s beta coefficient. YearMarket ReturnStock Return 1 8.4% 10.1% 2 10.2% 12.7% 3 2.3% 6.5% 4 15.6% 22.1% 5 -7.9% -9.3% Estimated OLS Regression Line: Correlation Coefficient:

4. Calculating Beta, cont.  Plot the stock’s return over time against the market’s return over time. Fit a (regression) line to the observations. The slope of the line is the firm’s estimated beta coefficient. Example #2: Given the following information, calculate the firm’s beta coefficient. YearMarket ReturnStock Return 1 6.6% 5.9% 2 -2.3% 4.6% 3 -14.5% 3.6% 4 7.1% 4.8% 5 15.9% 6.8% 6 18.3% 8.8% Estimated OLS Regression Line: Correlation Coefficient:

5. Portfolio Betas  The Beta of a portfolio is -  Example: Calculate the beta of the following 3 asset portfolio: Stock BetaPortfolio Weighting Fair Isaac & Co.1.50 20% Golden Books, Inc.2.75 30% General Motors0.90 50%

6. Integrating Risk & Return Required Return = Risk-Free Return + Premium for Risk  Security Market Line (SML) - Required Return on Stock I =

7. SML Examples  Ex. #1: Suppose Galoob Toys, Inc. has a beta of 2.0 (i.e. its returns are twice as volatile, and tend to move in the same direction as, market returns). If the risk free rate of interest in the economy is 5%, and the risk-premium available on an average (Beta = 1.0) security is 3.5%, what is the required rate of return on Galoob stock?  Ex. #2: Suppose the required rate of return on the market portfolio was 11%, the risk- free rate was 4%, and you were considering investing in Penske Motorsports which has a beta of 1.85. What is your required rate of return on Penske Motorsports stock?

8. Implementing the SML  Graphing the SML:  Complications: FInflation - FRisk Aversion - FChanging Betas -

9. Investment Decisions & the SML  Decision Rules:  If  Greater (Bigger) Fool Theory -