17. Expected Return

Learn Equity Risk, CAPM, Default Risk, Bond Ratings, and Interest Rates in Frugal Finance’s complete finance courses.

Equity Risk

Understanding Equity Risk and Expected Returns involves three main steps: identifying risk by comparing actual returns to expected ones, measuring risk by understanding deviations from those expected returns, and considering factors like skewness and kurtosis.

The course distinguishes between rewarded and unrewarded risk in investment contexts, including company-specific risks and market risks. Various types of risks, such as project-specific, competitive, industry-specific, international, and market risks, are explored, along with tactics for mitigation, including diversification.

CAPM

It provides an in-depth evaluation of the Capital Asset Pricing Model (CAPM), covering its assumptions, effects for investors, computation of expected returns, and the role of beta in evaluating asset risk relative to the market portfolio.

The idea of default risk in borrowing scenarios is discussed, focusing on how borrowers’ risk of failing to make required payments impacts interest rates on loans. Students learn about evaluating and managing default risk in lending and investment contexts, including discussions on company-specific default risk and its correlation with interest rates.

Rating Agencies

The course also covers bond ratings, including how ratings agencies evaluate companies, the importance of ratings for investors and issuers, and the impact of ratings on raising funds. It discusses the distinction between investment-grade and junk bonds, as well as the financial ratios used to assess default risk.

Finally, it looks into the relationship between bond ratings and interest rates, emphasizing how higher-rated bonds typically carry lower interest rates due to lower default risk. Discussions include default spreads, fluctuations in default risks over time, and the impact of economic conditions on bond markets.