Chapter 5 Risk and Return.

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Presentation transcript:

Chapter 5 Risk and Return

The variability of returns from those that are expected. Defining Risk The variability of returns from those that are expected.

Required Rate of Return Rj = Rf + bj(RM – Rf) Rj is the required rate of return for stock j, Rf is the risk-free rate of return, bj is the beta of stock j (measures systematic risk of stock j),

Determination of the Required Rate of Return Lisa Miller at Basket Wonders is attempting to determine the rate of return required by their stock investors. Lisa is using a 6% Rf and a long-term market expected rate of return of 10%. A stock analyst following the firm has calculated that the firm beta is 1.2. What is the required rate of return on the stock of Basket Wonders?

BWs Required Rate of Return RBW = Rf + bj(RM – Rf) RBW = 6% + 1.2(10% – 6%) RBW = 10.8% The required rate of return exceeds the market rate of return as BW’s beta exceeds the market beta (1.0).