Risk and return relationship
Why does the average stock have a Beta of one?
The beta measures the amount that investors expect the stock market to
change for each additional 1 % change in the market. The market is
similar to a portfolio of all stocks. The average stock has got the same
volatility as the market and therefore will move the same as the market,
which results in a Beta of one.
What is a market portfolio?
A theoretical bundle of investments that includes every type of asset
available in the world financial market, with each asset weighted in
proportion to its total presence in the market. The expected return of a
market portfolio is identical to the expected return of the market as a
whole. Because a market portfolio is completely diversified, it is subject
only to systematic risk (risk that affects the market as a whole) and not to
unsystematic risk (the risk inherent to a particular asset class).
The essence of the Capital Asset Pricing Method
The CAPM says that the expected return of a security or a portfolio equals
the rate on a risk-free security plus a risk premium. Each security its
expected risk premium should increase in proportion to its Beta.
Company cost of capital
The company cost of capital is the rate of return that investors require on
a portfolio of all the company its outstanding debt and equity, usually
calculated after tax.
Why does the average stock have a Beta of one?
The beta measures the amount that investors expect the stock market to
change for each additional 1 % change in the market. The market is
similar to a portfolio of all stocks. The average stock has got the same
volatility as the market and therefore will move the same as the market,
which results in a Beta of one.
What is a market portfolio?
A theoretical bundle of investments that includes every type of asset
available in the world financial market, with each asset weighted in
proportion to its total presence in the market. The expected return of a
market portfolio is identical to the expected return of the market as a
whole. Because a market portfolio is completely diversified, it is subject
only to systematic risk (risk that affects the market as a whole) and not to
unsystematic risk (the risk inherent to a particular asset class).
The essence of the Capital Asset Pricing Method
The CAPM says that the expected return of a security or a portfolio equals
the rate on a risk-free security plus a risk premium. Each security its
expected risk premium should increase in proportion to its Beta.
Company cost of capital
The company cost of capital is the rate of return that investors require on
a portfolio of all the company its outstanding debt and equity, usually
calculated after tax.
