Essay about Business

763 Words Sep 16th, 2013 4 Pages
FINCorporate Financial Policy: Risk, Return and the CAPM
Jide Wintoki

Fall 2013

Jide Wintoki (University of Kansas)

Business Investment (FIN 468)

Fall 2013

1 / 13

Lecture Outline

The Relationship Between Risk and Return The Security Market Line Calculating Individual Stock Betas Validity and the Role of the CAPM Some Alternative Theories

Jide Wintoki (University of Kansas)

Business Investment (FIN 468)

Fall 2013

2 / 13

Risk and Return

The return earned on investments represents the marginal benefit of investing. Risk represents the marginal cost of investing. For any project to create value, the marginal benefit must exceed the marginal cost of investing.

Jide Wintoki (University of Kansas)
…show more content…
The denominator is the market’s variance. In the CAPM, a stock’s systematic risk is captured by beta. The higher the beta, the higher the expected return on the stock.

Jide Wintoki (University of Kansas)

Business Investment (FIN 468)

Fall 2013

8 / 13

Beta And Expected Return
Beta measures a stock’s exposure to market risk The market risk premium is the reward for bearing market risk: Rm − Rf

E(Ri) = Rf + ß [E(Rm) – Rf]

• Return for bearing no market risk (risk-free rate)

• Stock’s exposure to market risk (beta)

• Reward for bearing market risk (market premium)

Jide Wintoki (University of Kansas)

Business Investment (FIN 468)

Fall 2013

9 / 13

Calculating Expected Returns
E (Ri ) = Rf + βi [E (Rm − Rf )]

Assume
Riskfree rate = 2% Market risk premium = 6% If Stock’s Beta Is Then

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