analytical methods for lawyers (finance)
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Analytical Methods for Lawyers (Finance). Risk Discount rate Capital Asset Pricing Model (CAPM). (last updated 20 Apr 09). Merton on risk. What is the value of $1000?. What is the value of $1000? Nominal? When? Risk?. Value a business. spreadsheet. What is risk?. - PowerPoint PPT PresentationTRANSCRIPT
Analytical Methodsfor Lawyers (Finance)
Risk
Discount rate
Capital Asset Pricing Model(CAPM)
(last updated 20 Apr 09)
Merton on risk
What is the value of $1000?
What is the value of $1000?
Nominal?When?Risk?
Value a business
Year Revenues Earnings
1 1,600,000 134,000
2 1,755,000 256,000
3 1,259,000 122,000
4 1,560,000 195,000
5 1,900,000 220,000
Thereafter 2,100,000 234,000
spreadsheet
What is risk?
How do markets “price” risk?
What is ECMH?
What is CAPM?
ECMH
MarketInformation Price
Ronald Gilson(Stanford)
Reinier Kraakman (Harvard)
Can you beat the market?
Brownian motion(Louis Bachelier)
One hundred thousandlemings can’t all be wrong
How does the market value
risk and return?
Which investment would you choose?
Which investment would you choose?
Return
Risk
What is beta?
The Beta coefficient is a key parameter in CAPM.
It measures the part of the asset's statistical variance that cannot be mitigated by portfolio diversification, and thus is correlated with the return of assets in the portfolio.
Stock A Stock B
Compare returns to market average
Market average
Stock A
Market average
Stock B
Market average
Stock A
Market average
Stock B
Slope = 1.7 Slope = 0.6
Return(%)
Risk (measured as beta)
Risk vs. Return
Stock A = 1.7
Stock B = 0.6
Mkt = 1.0
Return
Risk vs. Return
Stock A = 1.7
Stock B = 0.6
Mkt = 1.0
Return(%)
Risk (measured as beta)
Capital Asset Pricing Model
Mkt = 1.0
rf
rm
Risk (measured as beta)
Return(%)
Capital Asset Pricing ModelE(r) = rf + rm- rf )
Beta = 1.7
Beta = 0.6
Mkt = 1.0
rf
rm
E(r)
E(r)
Return(%)
Risk (measured as beta)
Solve for beta …
Beta = 0.6
Mkt = 1.0
rf = 3.2%
rm= 11.7%
E(r)
Return(%)
Risk (measured as beta)
Assume: rm = 11.7% / rf = 3.2%
E(r) = rf + rm- rf )E(r) = 3.2% + 0.6*(11.7% – 3.2%)E(r) = 3.2% + 0.6*(8.5%)E(r) = 3.2% + 5.1% = 8.3%
Beta = 1.7
Mkt = 1.0
E(r)
Return(%)
Risk (measured as beta)
Assume: rm = 11.7% / rf = 3.2%
E(r) = rf + rm- rf )E(r) = 3.2% + 1.7*(11.7% – 3.2%)E(r) = 3.2% + 1.7*(8.5%)E(r) = 3.2% + 13.45% = 16.65%
rm= 11.7%
rf = 3.2%
It’s better to be vaguely right,
than precisely wrong …
Study after study has found that beta
isn't a good measure of risk …
END