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Lecture Investment analysis & portfolio management - Chapter 29

After studying this chapter you will be able to understand: Systematic and unsystematic risk – continuation, capm formula, uses of capm, limitations of capm, to apply the adjusted present value approach to decision making. | Investment Analysis and Portfolio management Lecture: 29 Course Code: MBF702 Outline RECAP SYSTEMATIC AND UNSYSTEMATIC RISK – CONTINUATION CAPM FORMULA USES OF CAPM LIMITATIONS OF CAPM TO APPLY THE ADJUSTED PRESENT VALUE APPROACH TO DECISION MAKING. SYSTEMATIC RISK Systematic risk is measured by a beta factor therefore the required return from an investment must be related to the beta factor of that investment.This is brought together in the Capital Asset Pricing Model which is a formula that relates required returns to beta factors, or measures of systematic risk. CAPM - formula Example The risk-free rate of return is 4% and the return on the market portfolio is 8.5%. What is the expected return from shares in companies X and Y if: the beta factor for company X shares is 1.25 the beta factor for company Y shares is 0.90? Illustration The following information is available: Risk-free rate of return 4.0% Expected market return 7.5% Standard deviation of market return 1.4% Standard . | Investment Analysis and Portfolio management Lecture: 29 Course Code: MBF702 Outline RECAP SYSTEMATIC AND UNSYSTEMATIC RISK – CONTINUATION CAPM FORMULA USES OF CAPM LIMITATIONS OF CAPM TO APPLY THE ADJUSTED PRESENT VALUE APPROACH TO DECISION MAKING. SYSTEMATIC RISK Systematic risk is measured by a beta factor therefore the required return from an investment must be related to the beta factor of that investment.This is brought together in the Capital Asset Pricing Model which is a formula that relates required returns to beta factors, or measures of systematic risk. CAPM - formula Example The risk-free rate of return is 4% and the return on the market portfolio is 8.5%. What is the expected return from shares in companies X and Y if: the beta factor for company X shares is 1.25 the beta factor for company Y shares is 0.90? Illustration The following information is available: Risk-free rate of return 4.0% Expected market return 7.5% Standard deviation of market return 1.4% Standard deviation of return from shares in company ABC 2.5% Correlation coefficient for returns from shares in Company ABC and returns from the market as a whole 0.90 Required (a) Calculate the beta factor for Company ABC shares. (b) Estimate the returns currently expected from Company ABC shares. The beta factor of a small portfolio A portfolio of investments containing just a few securities will not be fully representative of the market portfolio. Its systematic risk will therefore be different from the systematic risk for the market as a whole. The relationship between the systematic risk of a small portfolio and the systematic risk of the market as a whole can be measured as a beta factor for the portfolio. A beta factor for a portfolio is the weighted average value of the beta factors of all the individual securities in the portfolio. The weighting allows for the relative proportions of each security in the portfolio. Example A portfolio contains five securities. The proportions of each .