1. Expected Return for Individual Stocks
Probability x Return = ___%
Expected Return = ___
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2. Calculating Expected Return
Stock A
Stock B
Probability
Return
10%
-15%
-1.5%
20%
-50%
-10%
40% 4%
30% 0%
50%
25%
12.5%
Expected Return
15%
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3. Expected Return for Portfolio
Portfolio Weight x Return = ___%
Expected Return = ___
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4. Portfolio Expected Return
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5. Portfolio Beta Investment Beta Stock Q: 20% of portfolio
Stock R: 20% of portfolio
1.4 .6
.28
.12
Stock S: 10% of portfolio
Stock T: 50% of portfolio
1.5
1.8
.15
.90
Portfolio Beta
1.45
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6. Standard Deviation of Portfolio
Not the average of standard deviation for portfolio components
Calculation
Calculate expected return for portfolio under each condition
Then determine deviation from expected return from portfolio, square it, multiply times probability, sum it, and take the square root…which sounds familiar…
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7. Risk Unsystematic: impacts a single stock or industry
Dole recalls spinach
Systematic: impacts most, if not all, stocks
Fed leaves interest rates unchanged
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8. Diversification
Create a portfolio of 20 stocks with a low correlation: chart on Page 338
This would eliminate almost all unsystematic risk
Unsystematic risk is not rewarded
Investing 90% of your portfolio in one stock
Low correlation: stocks that don’t tend to move in the same direction
Airline and oil stocks, for example
Capital Markets

9. CAPM and SML
SML: reflects risk-reward ratio for an individual security
Risk is measured by beta
Assumes security is in a diversified portfolio
How much risk does a security add to a diversified portfolio?
Capital Markets

10. CAPM
ER = RF + (MR – RF) x B
RF = “Risk-free” rate of return on T-bills
Currently __%
MR = Expected Return for the Market
Approximately 12% for large-cap stocks
B = Beta
What happens to Expected Return if the Market has additional risk? If the asset’s beta increases?
Capital Markets

11. Beta Measures systematic risk Market = 1.0 Can beta be negative?
Not total risk since it doesn’t include unsystematic risk
Market = 1.0
Can beta be negative?
Can betas be different if you look at different sources?
Generally based on 5-year moving average
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12. CAPM
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13. Coefficient of variation
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14. Reward/Risk Relationship
Coefficient of variation = Reward / Risk
= Expected return / Standard deviation or Beta
Textbook: Reward-to-risk ratio
In an efficient market, should be the same for all assets
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15. News and Expected Returns
Surprise news: impacts stock price
MSFT earnings are below estimates
Inflation is higher than expected
What the market already knows is discounted into current stock price
Capital Markets