investors require to compensate them for bearing that risk? To begin, let us define the
following terms:
rˆiexpectedrate of return on the ith stock.
rirequiredrate of return on the ith stock. Note that
ifrˆiis less than ri, you would not purchase this
stock, or you would sell it if you owned it. Ifˆri
were greater than ri, you would want to buy the
stock, because it looks like a bargain. You would
be indifferent ifrˆiri.
realized, after-the-fact return. One obviously
does not know what will be at the time he or
she is considering the purchase of a stock.
rRFrisk-free rate of return. In this context, rRFis
generally measured by the return on long-term
U.S. Treasury bonds.
bibeta coefficient of the ith stock. The beta of an
average stock is bA1.0.
r
r
The Relationship between Risk and Rates of Return 131
FIGURE 3-11 Calculating a Beta Coefficient for Wal-Mart Stores
Historic Realized
Returns
on Wal-Mart, rj (%)
Historic Realized Returns
on the Market, rM (%)
rj = 2.32% + 0.506 rM
R^2 = 0.0752
30
20
10
-30 -20 -10 0 10 20 30
-10
-20
-30
_
_
_
Risk and Return 129
