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Week 3 Notes

The document outlines key risk metrics such as standard deviation, coefficient of variation, and beta, which help assess investment risks. It emphasizes the importance of diversification in reducing unsystematic risk and introduces the Capital Asset Pricing Model (CAPM) that focuses on portfolio risk. Additionally, it provides formulas for calculating expected return, portfolio beta, required return, and market risk premium.

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Daniel Gor
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2 views1 page

Week 3 Notes

The document outlines key risk metrics such as standard deviation, coefficient of variation, and beta, which help assess investment risks. It emphasizes the importance of diversification in reducing unsystematic risk and introduces the Capital Asset Pricing Model (CAPM) that focuses on portfolio risk. Additionally, it provides formulas for calculating expected return, portfolio beta, required return, and market risk premium.

Uploaded by

Daniel Gor
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Week 3 Notes

• Risk Metrics:

o Standard Deviation: Measures the spread of returns; higher values imply more risk.

o Coefficient of Variation: Standardized risk measure (useful for comparing different


investments).

o Beta: Measures market (systematic) risk. A beta of 1 means the stock moves with the
market.

• Diversification:

o Reduces unsystematic risk but cannot eliminate systematic risk.

o Effective when stocks have low correlations.

• Capital Asset Pricing Model (CAPM):

o Focuses on portfolio risk rather than individual stock risk.

o Relevant risk is a stock's contribution to the risk of a diversified portfolio.

• Investment Strategies:

o Large, diversified portfolios minimize diversifiable risks.

o Market risks like economic events impact all investments and cannot be avoided.

Formulas

Expected Return = (Probability*Return) + (Probability*Return) + (Probability*Return)


𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛
Coefficient of variation = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛

Portfolio Beta = (Weight of stock * Beta) + (Weight of stock * Beta)


𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑡𝑜𝑐𝑘
Weight of a stock = 𝑇𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑

Required Return = Risk free rate + (Beta*Market Risk Premium)

Market risk Premium = Market Rate – Risk Free rate


𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛−𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒 𝑅𝑎𝑡𝑒
Market Risk Premium = 𝐵𝑒𝑡𝑎

𝑅𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑅𝑒𝑡𝑢𝑟𝑛−𝑅𝑖𝑠𝑘 𝐹𝑟𝑒𝑒 𝑅𝑎𝑡𝑒


Beta = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑖𝑠𝑘 𝑃𝑟𝑒𝑚𝑖𝑢𝑚

Risk free rate = Required Return - (Beta*Market Risk Premium)

Market Return = Market Risk Premium + Risk-Free Rate

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