Fin 515

Fin 515 Week 3 Discussion Part 2

Expected rate of return is the rate of return expected on a stock given its current price and expected future cash flows. If the stock is in equilibrium, the required rate of return will equal the expected rate of return. If you multiply each possible outcome by its probability of occurrence and then sum these products, the result is a weighted average of outcomes. The weights are the probabilities, and the weighted average is the expected rate of return. The tighter the probability distribution, the more likely it is that the actual outcome will be close to the expected value, the less likely it is that the actual return will end up below the expected return. The tighter the probability distribution, the lower the risk assigned to a stock (P. 221 & 223). The required rate of return is difficult to pinpoint due to the various estimates and preferences from one decision maker to the next. Risk return preferences, inflation expectations, and a corporation's capital structure play a role in determining the required rate.

EXAMPLE from the net: If a stock currently trades at $10 a share and an analyst expects the stock to reach $20 by year-end, the investor obtains the expected rate of return by dividing the expected price by the current price minus the current price of the asset. For this example, the expected rate of return would be $20 divided by $10 minus $10 for an expected rate of return of 100 percent

Difference Between Expected Rate of Return vs. Rate of Return | eHow.com http://www.ehow.com/info_12035212_difference-between-expected-rate-return-vs-rate-return.html#ixzz2IWC0MHPL

The relevant risk of a stock is the risk that remains once a stock is in a portfolio that is diversified and is contributing to the market risk of the portfolio. This relevant risk can be measured by the extent to which the particular stock moves down or up in the stock market. This relevant risk is measured by a metric called beta coefficient...