Risk,Return and the CAPM (L6)

Question 1

How to calculate capital gains

Answer 1

P1-P0

Question 2

How to find return of an investment

Answer 2

P1-P0+DIV/P0
DIV=dividend

Question 3

Types of investment

Answer 3

Treasury bills
Treasury bonds
Stocks

Question 4

Treasury bills

Answer 4

Bonds of short maturity issued by US gov. Safest investment, no default risk

Question 5

Treasury bonds

Answer 5

Bonds of long term maturity, riskier than treasury bills but still safe (some exposure to macro conditions)

Question 6

Stocks

Answer 6

Riskiest of the 3, there’s default risk, exposure to macro conditions, unstable prices . don’t know if you’ll get paid

Question 7

Asset risk premium

Answer 7

Asset return-return of a risk-free asset (treasury bills)

Question 8

Average return

Answer 8

sum of all r/ T
average performance
r=return

Question 9

Variance and sd

Answer 9

(rt-r(mean) )^2 x 1/T
sqr ^
measures risk, if variance is high, higher risk

Question 10

Diversification

Answer 10

investing in more than 1 asset to reduce investment risk/variance
stocks must have a low correlation between each other

Question 11

market portfolio

Answer 11

includes all assets of the economy to offer highest degree of diversification theoretically

Question 12

sources of risk

Answer 12

systematic risk
unsystematic risk

Question 13

systematic risk

Answer 13

external risk that can’t be eliminated
recessions, interest rates, war, gov policy

Question 14

unsystematic risk/idiosyncratic

Answer 14

employee strikes, ceo being fired etc, can be eliminated by diversifying

Question 15

market risk

Answer 15

investors are interested in what reward they get for taking the systematic risk

measured by beta, measures sensitivity of a stock

Question 16

Required return

Answer 16

risk free return+risk premium

Question 17

capital asset pricing model
CAPM

Answer 17

E(r)=rf+B(E(rm)-rf)
expected return= riskless rate of return+B(market return-risk free)=discount rate