Beta and CAPM

Finance

Expected rate of return of equity investors is also known as the cost of (equity) capital to the firm raising funds

The total risk of an asset consist of two components

• specific risk

• Unspecific risk

Risk is ur own asset risk and the market risk.

What does statistics tell us about price?

If we plot daily price changes it would follow a normal distribution.

The efficient market hypothesis states that securities prices accurately reflect future expected cash flows ans are based on all information available to investors.

For equity evaluation questions

If a series of dividends payments are given - start looking for a dividend discount formula i can use to answer the question.

If a single dividend payment is given then to answer the question i will need to use a perpetuity formula.

Market are likely to be efficient in the semi strong form.

Beta is our measurement of market risk for individual stocks.

• it captures the sensitivity of the return of the stock to the movements in market returns

A stocks contribution to the risk of a well diverse portfolio depends on its beta.

Efficient portfolios offer the highest expected return for any level of risk.

Investors track sharpe ratios to measure the risk adjusted performance of investment managers.

Beta = covariance between the stock return and the market return / variance of the return on market

Risk premium = Total return - Risk free rate (interest rate)

A Portfolio risk is measured by beta. And the standard deviations are irrelevant.