Lecture 2 - Risk & CAPM

Question 1

greater spread in ave return implies

Answer 1

greater risk

aka greater returns

Question 2

risk premium

Answer 2

ave excess return required over and above the risk-free rate

compensation for risk

Question 3

expected return =

Answer 3

risk premium + risk free rate

Question 4

finding expected return of an asset

Answer 4

take average of all possible outcomes, weighted by their probabilities

Question 5

measuring risk

Answer 5

use SD of possible returns

aka square root of variance

Question 6

systematic risk

Answer 6

risk that influences a large # of assets
market risk
un-diversifiable risk

Question 7

unsystematic risk

Answer 7

risk that affects certain assets but cancels out overall

diversifiable risk

Question 8

risk free rate

Answer 8

compensation for time value of money

Question 9

what determines a asset’s risk premium?

Answer 9

if asset is exposed to more systematic risk

since you can diversify away unsystematic risk, only systematic risk is rewarded

Question 10

systematic risk principle

Answer 10

expected return on a risky asset depends only on its exposure to systematic risk

Question 11

beta

Answer 11

measure of an asset’s exposure to systematic risk

sensitivity of a stock’s return to the return on the market portfolio

Question 12

if asset’s beta

Answer 12

asset will reduce portfolio variance

Question 13

if asset’s beta > beta of your current portfolio

Answer 13

asset will increase portfolio variance

Question 14

E(rm)

Answer 14

expected return on market portfolio

compensation for all systematic risk in the economy

Question 15

σm^2

Answer 15

variance of market portfolio

quantifies systematic risk of the econ

Question 16

β =

Answer 16

σim/(σm^2)

covariance of stock i with market return) / (variance of market return

Question 17

covariance of stock i return with market return

Answer 17

σim = ρimσiσm

Question 18

calculating beta for portfolio

Answer 18

calculate mean of asset’s betas using portfolio weights

Question 19

CAPM =

Answer 19

E(ri) = rf + βi[E(rm) - rf]

β[E(rm) - rf] = risk premium for stock

Question 20

market risk premium

Answer 20

[E(rm) - rf]
diff b/w expected return on a market portfolio and the risk free rate
reward for bearing risk

Question 21

risk premium for stock

Answer 21

β[E(rm) - rf]