Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
You are about to invest in Terrali ltd and the company’s stock’s return has the following distribution:
Demand for the Probability of this
Company’s products Demand occurring Demand occurs
Weak 0.1 (50%)
Below average 0.2 (5%)
Average 0.4 16%
Above average 0.2 25%
Strong 0.1 60%
1.0
REQUIRED:
(a) Calculate the stock’s:
- Expected return.
- Standard deviation.
(b) Distinguish between the expected return from the required return.
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