risk, return, and the capital asset pricing model john marron
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Risk, Return, and the Capital Asset Pricing Model
John Marron
RISK
Total Risk = Systematic + Unsystematic Risk
Systematic Risk is also called Nondiversifiable
Risk or Market Risk
Unsystematic Risk is also called Diversifiable
Risk or Unique Risk
Diversification
Can eliminate some risk
Unsystematic risk tends to disappear in a large portfolio
Systematic risk never disappears
Beta
Beta = How much systematic risk a particular asset has relative to an average assetFor example:
XOM: 0.65VIAB: 1.22YHOO: 3.56MII Portfolio: 1.54
Capital Asset Pricing Model
Er = Rf + B{E(Rm)-Rf}
Works for both individual assets and portfolios
McIntire Investment Institute
Example:
If Rf = 5.5%
Market Risk Premium = 7%
Then the MII should return:
Er = 5.5% + 1.54(12.5%-5.5%)
Er = 16.28%
Expected Return depends on 3 things
The time value of money (risk-free rate, Rf)
The reward for bearing systematic risk (market risk premium={E(Rm) - Rf}
The amount of systematic risk (Beta)
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