Standard Deviation, Expected Return & Required Return

CFA Level II Portfolio Management
#1

  1. Kaplan Pg 180-Professor’s Note- it says “that SML uses Beta, not Std Dev, as an independent variable because Market Portfolio takes an unsystematic risk away so investor price only systematic risk. Ok. Then why CML, which uses Market Portfolio too , uses Std Dev ( total risk) not Beta.???”

  2. Kaplan Pg 177 along with Pg 179 -Example- says " Calculate Require Return=E(Rsa)=11.5%. In explanation it says that if investor predict ( based on DDM Exp Return? ) that if the return exceeds 11.5%, then they should buy, in the same context in Pg 179 it says if Req Ret is too low mean Market Price is too High. How? and SML predicts investor will Sell stock. _ Aren’t these two statements contradicting? _

  3. what is Req Ret, Exp Ret and Forecasted Ret in this context?

#2

Got it. As denominator is low, Price has to be high…Silly…but still can’t figure out rest of the questions?

#3

NO1??? @S2000magician or any1? Is that too easy question?

#4

Beta is a regression on the market portfolio. Standard deviation for the CML must capture total risk since total risk for a market portfolio = systematic risk, so you can’t use beta as a measure of risk since it’s always equal to one.

A low required return increases the price of the asset, since it’s less risky and therefore demands less discounting compared to a riskier asset, with a risk free rate needing the least discount rate (or minimum required rate of return). If the expected return is lower than the required return according to the SML, then invstors will sell the asset until it’s price can match the expected return (which could be the new required return), or until the expected return reverts back to it’s required return previously known.

Return and price are inversely related. If you demand (or expect) a high return, then paying more for it than you should will cancel out the high expected return for it’s original price, since you paid more and thus reduced your return on investment. Required return is a percntile figure that is fixed, while expected return from different market participants determine the fair value of the asset relative to your valuation, but it doesn;t mean you will be right and get what you expect to recieve above the opportunity cost.

#5

Thanks MrSmart… Really appreciate.