FM chapter 6

investment generates come in the form of cash flows (isn't accounting profits)

potential variability in future cash flows. wider the range of possible events that occur, greater the risk

risky but offers the potential of a higher payoff (compared to treasury)

one way to measure risk. it measure volatility or riskiness of portfolio returns

direct

common stocks

combining several assets

• systematic (market risk): risk that affects all firms (tax rates)
• unsystematic (company unique risk): risk that affects only a specific firm

creating a portfolio of stocks

reduce the overall risk exposure

if two stocks are perfectly positively correlated, diversification has no effect on risk

if two stocks are perfectly negatively correlated, the portfolio is perfectly diversified (want this one)

line of best fit for all the stock returns relative to returns of company

measures average relationship between a stock's returns and those of the company's return

beta

• risk that remains for a company even after we have diversified our portfolio-
• stock with beta of 0 = no systematic risk
• stock with beta 1 = systematic risk = to typical stock in marketplace
• stock beta > 1 has sytematic risk greater than "typical stock"

.60 and 1.60

change on average of the portfolio for every 1% change in the gneral market

diversification b/c it brings lower risk without sacrificing expected returns and we can increase expected returns w/o having to assume more risk

diversifying among different kinds of asset types; have to do it today and decision made today will be the payoff in the future

move from all stock portfolio to a mix of stocks and bonds to an all bond portolio, both risk and return decline

risk declines

minimum rate of return necessary to attrack an investor to purchase or hold a security (opportunity cost)

RROR or discount rate for risk-less investments and measured by U.S. treasury bill rate

additional return we must expect to recieve for assuming risk; level risk increases we demand additional expected returns

thinking about the return that an investor should require on an investment, given the asset's systematic or market risk

graphic representation of the CAPM- line shows the appropriate RROR for a given stock's systematic risk