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of Return
Required Risk-free
rate of = rate of
return return
Since Treasuries are essentially free of
default risk, the rate of return on a
Treasury security is considered the
risk-free rate of return.
For a corporate stock or bond,
what is the required rate of return?
s = S (ki -
n
k) 2 Pi
i=1
Summary
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Portfolio beta
The relationship between a portfolios returns
and the markets different returns
A measure of the portfolios nondiversifiable
risk
portfolio =(% invested in stock j) x ( of stock j)
What is the Required Rate of
Return?
market company-
risk unique risk
Required Risk-free Risk
rate of = rate of + premium
return return
market company-
risk unique risk
can be diversified
away
This linear relationship between
risk and required return is
known as the Capital Asset
Pricing Model (CAPM).
PRINCIPLE 2:
Return
Risk
THE HIGHER THE RISK, HIGHER
RETURN.
The CAPM equation: