Chapter 6. Risk, Return, and CAPM
Dollar return: Amount to be received-Amount invested
Rate of return: Amount received-Amount investedAmount invested
Stand-alone risk is the risk an investor has in just holding the one asset
Expected rate of return: r=i=1npiri Where P is probability of i outcome and r is the rate of return
The more leptokurtic the distribution, the more likely the actual outcome will be closer to the expected return.
Measuring Standalone Risk: Standard Deviation 1. Expected Rate of return 2. Deviationi= ri-r 3. Variance=σ2=i=1n( ri-r)2Pi 4. Standard Deviation=σ=Variance 5. Or use Excel of Financial calculator

Using Historical Data to Measure Risk:
Realized Rates of Return: rAvg=t=1nrtn
Standard Deviation of the Sample Returns: σ=S=t=1n(rt-rAvg)n-1
In Excel use =Average and =STDEV functions
Measuring Standalone Risk: Coefficient of Variation
Coefficient of variation = CV=σr
Risk Aversion and Required Rate of Return
Assume risk aversion for investors
Textbook Example:
Basic Food’s Price up to $150 from $100
Sale.com Price down to $75 from 100.
Difference in return, 20%-10%= Risk Premium
Risk in Portfolio Context
Expected return on portfolio=Weighted expected return=rp=i=1nwiri
Portfolio Risk
Stocks can be combined into portfolios which then become less risky to riskless depending on the correlation of the assets. Stocks with a ρ=-1 are perfectly negatively correlated. The inverse is positively correlated.
Expected ρ also called R = t=1n(ri,t-ri,Avg)(rj,t-rj,Avg)[t=1n(ri,t-ri,Avg)2][t=1n(rj,t-rj,Avg)2]
Where i and j are stocks ri,t is the actual return for stock i in period t and ri,Avgis average return during n period sample
Or just use =CORREL function in Excel
Diversification does NOTHING to reduce risk if stocks are perfectly positive correlated!!!
Diversifiable Risk VS Market Risk

Almost