Chapter 8 is an introduction to risk. Different securities bare different risks and returns. Over the last 107 years, US treasury bills provided and average return of 4% each year. The stock market returned an averag of 11.7%. These numbers give two benchmarks for the [[Opportunity Cost]]s of capital.

Risk is best judged in a portfolio context. Most investors do not put all their eggs in one basket. Risk is unpredictable. The spread of possible outcomes is measured by the [[standard deviation|Standard error]]. The standard deviation of the [[Market Portfolio]] is around 15% to 20% per year. The sensitivity to market movements is called the [[Beta]].

The variance of a portfolio can be calculated, see [[Calculating Portfolio Variance]].

A diversified portfolio investing in stocks with a beta of 2.0 will have twice the risk of  a diversified portfolio with a beta of 1.0. Diversification is a good thing for the //investor//. This does not mean that firms should diversify. Corporate diversification is redundant if investors can diversify on their own account. As diversification does not affect the firms value, [[Present Value|PV]]s add even when risk is explicitly considered. Thanks to the [[Value Additivity]] the net present value rule works even under uncertainty.
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finance_public
created
Wed, 02 Feb 2011 21:05:20 GMT
creator
dirkjan
modified
Wed, 02 Feb 2011 21:05:20 GMT
modifier
dirkjan
tags
Principles of Corporate Finance
creator
dirkjan