logo image

Different risk profile Essay

Expected Return: This is the return that an individual expects a security to earn over the next period. This is only an expectation and the actual return may be higher or lower. An individual’s expectation may simply be the average return per period a security has earned in the past. Alternatively, it may be based on a detailed analysis of a firm’s prospects, on some computer-based model, or on inside information. Capital Asset Pricing Model: The Capital Asset Pricing Model (CAPM) measures the risk premium for a capital investment by comparing the expected return on that investment with the expected return on the entire securities market.

In other words, the expected return on the market is the sum of the risk-free rate plus some compensation for the risk inherent in the market portfolio. The CAPM summarizes this relationship by the following equation. In words, the expected return on the market is the sum of the risk-free rate plus some compensation for the risk inherent in the market portfolio. The above equation refers to the expected return on the market, not the actual return in a particular month or year.

As securities have risk, the actual return on the market over a particular

Need essay sample on "Different risk profile"? We will write a custom essay sample specifically for you for only $ 13.90/page

period can be below Rf, or can even be negative. Since investors want compensation for risk, the risk premium is presumed to be positive. It is generally argued that the best estimate for the risk premium in the future is the average risk premium in the past. The average annual risk free return over the past 3 years has been close to 3 percent and the average annual return of the market has been close to 12 percent. Thus, the average difference between the two is 9 percent, which is the risk premium.

Step 2 – Calculation of the Expected Return on Individual Security We believe that the beta of a security is the appropriate measure of risk in a large, diversified portfolio and the expected return on a security should be positively related to its beta. There are two ways to determine the beta of a stock. The first one is by using the formula mentioned below:. We can also estimate beta by running a linear regression of the return on the securities against the excess return on the market (Rm – Rf).

In practice, running a regression involves gathering a number of observations of return on the security over a period together with observations for the same period on a variable that somehow captures the market-wide factors. We assume that return on the market portfolio epitomizes the impact of market-wide factors. Therefore, for every observation that we have for the security, we shall also gather information on the return on the market portfolio for the same period.

Can’t wait to take that assignment burden offyour shoulders?

Let us know what it is and we will show you how it can be done!
×
Sorry, but copying text is forbidden on this website. If you need this or any other sample, please register

Already on Businessays? Login here

No, thanks. I prefer suffering on my own
Sorry, but copying text is forbidden on this website. If you need this or any other sample register now and get a free access to all papers, carefully proofread and edited by our experts.
Sign in / Sign up
No, thanks. I prefer suffering on my own
Not quite the topic you need?
We would be happy to write it
Join and witness the magic
Service Open At All Times
|
Complete Buyer Protection
|
Plagiarism-Free Writing

Emily from Businessays

Hi there, would you like to get such a paper? How about receiving a customized one? Check it out https://goo.gl/chNgQy

We use cookies to give you the best experience possible. By continuing we’ll assume you’re on board with our cookie policy