Summary (2)
by Maestri- The relevant risk of an individual asset is its contribution to the riskiness of a welldiversified portfolio, which is the asset’s market risk. Since market risk cannot be eliminated by diversification, investors must be compensated for bearing it.
- A stock’s beta coefficient, b, is a measure of its market risk. Beta measures the extent to which the stock’s returns move relative to the market.
- A high-beta stock is more volatile than an average stock, while a low-beta stock is less volatile than an average stock. An average stock has b 1.0.
- The beta of a portfolio is a weighted average of the betas of the individual securities in the portfolio.
- The Security Market Line (SML) equation shows the relationship between a security’s market risk and its required rate of return. The return required for any security i is equal to the risk-free rate plus the market risk premium times the security’s beta: ri rRF (RPM)bi.
- Even though the expected rate of return on a stock is generally equal to its required return, a number of things can happen to cause the required rate of return to change: (1) the risk-free rate can change because of changes in either real rates or anticipated inflation, (2) a stock’s beta can change, and (3) investors’ aversion to risk can change.
- Because returns on assets in different countries are not perfectly correlated, global diversification may result in lower risk for multinational companies and globally diversified portfolios.
In the next two chapters we will see how a security’s expected rate of return affects its value. Then, in the remainder of the book, we will examine ways in which a firm’s management can influence a stock’s risk and hence its price.
Taken From : Five-Minute MBA – Corporate Finance
No related posts.
Related posts brought to you by Yet Another Related Posts Plugin.
