Equity Markets and Portfolio Analysis

CHAPTER 6 Expected Rate of Return and Risk—Stock

Introduction

Although knowledge of present or past returns is important for security analysts, an investor is more concerned with what a security will yield in the future; that is, she wants to know the expected rate of return, as well as the chance that her expectations might be wrong. For example, after an in-depth analysis, an investor might think a stock would generate a 20 percent rate of return, but she also knows that under certain scenarios she might lose 10 percent or gain as much as 35 percent. Similarly, a bond investor who sees a bond trading to yield 10 percent also knows there is a chance of default in which he might lose 70 percent and also a chance that rates in the market ...