the following data to find out the risk-free rate. The correlation coefficient between Google returns and Yahoo returns is -1. Assets Google Yahoo Expected Return (%) 6.78% 9.59% Standard Deviation (%) 3.37% 5.35%
the following data to find out the risk-free rate. The correlation coefficient between Google returns and Yahoo returns is -1. Assets Google Yahoo Expected Return (%) 6.78% 9.59% Standard Deviation (%) 3.37% 5.35%
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
Question
Transcribed Image Text:### Understanding the Risk-Free Rate Using Asset Returns
In financial analysis, particularly in portfolio management, understanding the relationship between different asset returns is crucial. One parameter that aids in determining an optimal portfolio is the risk-free rate. The following example illustrates how to use given data to find out the risk-free rate.
The correlation coefficient between Google returns and Yahoo returns is -1.
**Data Summary:**
| **Assets** | **Expected Return (%)** | **Standard Deviation (%)** |
|------------|------------------|-------------------------|
| Google | 6.78% | 3.37% |
| Yahoo | 9.59% | 5.35% |
**Assets Explanation:**
1. **Google:**
- **Expected Return:** 6.78%
- **Standard Deviation:** 3.37%
2. **Yahoo:**
- **Expected Return:** 9.59%
- **Standard Deviation:** 5.35%
### Interpretation of Data:
- The **expected return** is the anticipated average return from an investment in these assets.
- The **standard deviation** is a measure of the asset's volatility or risk; a higher percentage indicates higher volatility.
### Practical Application:
In finance, the correlation coefficient between two assets' returns can range from -1 to 1. A correlation coefficient of -1 in the given data implies a perfect negative relationship between Google and Yahoo returns, meaning when Google’s returns increase, Yahoo’s returns decrease proportionally, and vice versa. This relationship can be leveraged in portfolio construction to minimize risk by diversifying investments effectively.
By using the above data, finance professionals can utilize various models, such as the Capital Asset Pricing Model (CAPM), to determine the risk-free rate and the expected returns of a diversified portfolio. Understanding these metrics helps investors make well-informed decisions to optimize their investment strategies.
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