(graph + formula check ph notes)
Increase in Inflation causes Rf (The risk free rate) to increase by exactly the same amount, but (rm-rf)(the market risk premium) does not change. Therefor, k (the required rate) also increase exactly as the inflation rate.
Increase in Risk Adversion causes (rm-rf)(market risk premium) to increase but no change in rf(the frisk free ratio).
Ex. problem 1
Suppose the risk free rate is 2.4% and the market risk premium is 11.5%, the stocks beta is 1.3. If you expect that inflation rate to increase by 1.5% and the risk adversion to increase by 2.4%, how much would the stocks new required rate of return be?
K= (4,2+1.5) + (11.5+2.4)13 = 19.15%
23.77-19.15 = 4.62% in difference
Ex. problem 2
* Suppose you manage a 10-stock portfolio with equal allocations. The current Beta of this portfolio is 1.9 and you want to bring it down to 1.75. The beta of one of the stocks is 2.2, you want to replace this stock with a new one , how much should the beta of the new replacement stock be?
* Formula; ? check ph
* Quiz next Wednesday chapter 4
U.S. Gov U.S. Treasury Bond
State Gov Municipal Bonds “Munis”
County Gov -ll-
City Gov -ll-
U.S. Gov Agencies Fannie Mae (Buys mortgages from banks)FNMA SLMA
Corporations Corp bonds
Standard & Poors Moodys
Premium Bond AAA Aaa
High grade AA Aa Investment Grade Bonds
Upper medium A A
Medium Grade BBB Baa
* Lower Medium BB Ba
B B High Yield Bonds (Junk Bonds)
* Income Bond C C = Only have to pay interest if they earned a certain income.
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