Return Use CAPM when: ο Beta, risk free return, and market return are given Formula: ; where Rf – risk free, β – beta , Rm – return on market From this equation the following can be derived: Rm = πΈπ−π π π½ + π π Where values of Rm and Beta are given and Risk free is to be located: Rf = πΈπ−(π½∗π π) 1−π½ Situation: Market return and risk free return of two Stocks are to be located E.g Formula: Let: Rβ be return on Stock J Rβ be return on Stock K Rβ+ Rβ Rm = π½β+ π½β ; NOTE: use equation if and only if π½βπ πΉ + π½βπ πΉ cancel out, i.e = 0 To find Rf substitute Rm to CAPM formula of either Stock J or Stock K If Rm and β are not given and Risk free rate is to be computed use: Use variance when: Return in N occurrence and expected return, probability of occurrence are given Use Covariance when: Measuring relation between to assets Use correlation when Measuring relationship between two assets Note: Range is always within – 1 to + 1. The closer to zero the lesser the relation between assets Addendum: correlation and covariance are related BUT correlation is easier to analyze because of its limited range i.e -1 to +1 Other formulas to take note of: Risk and return Coefficient of variation : Beta: π½ = πππ£πππππππ ππ π π‘πππ π‘π π‘βπ ππππππ‘ ππππππππ ππ π‘βπ ππππππ‘ Weighted average of Portfolio Expected return for an individual investments Regression: Correlation: Regression analysis:
