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REAPING REWARD BY INCREASING RISK

Q: The Fama – French Three–Factor Model:

· Beta: From the Capital – Asset Pricing Model. · Size: Measured by total equity market capitalization. · Value: Measured by the ratio of market to book value. · Momentum: Capturing the tendency for rising or falling stocks to continue moving in the same direction. · Liquidity: Reflects the fact that investors need to be paid a return premium to induce the to hold illiquid securities. · Quality: The stability of the company’s earnings and sales growth and its low amount of debt are measured.

4 important questions on REAPING REWARD BY INCREASING RISK

Systematic risk/market risk:

Captures the reaction of individual stocks (or portfolios) to general market swings. Some stocks and portfolios tend to be very sensitive to market movements.
And cannot be eliminated by diversification.

Unsystematic risk / specific risk:

Is the variability in stock prices, and, therefore, in returns of stocks that result from factors peculiar to an individual company.

The capital–asset pricing model:

Returns for any stock, subsequently risk premiums, for any stock or portfolio will be related to beta, the systematic risk that cannot be diversified away.

The Fama – French Three–Factor Model:

· Beta: From the Capital – Asset Pricing Model.

· Size: Measured by total equity market capitalization.

· Value: Measured by the ratio of market to book value.

· Momentum: Capturing the tendency for rising or falling stocks to continue moving in the same direction.

· Liquidity: Reflects the fact that investors need to be paid a return premium to induce the to hold illiquid securities.

· Quality: The stability of the company’s earnings and sales growth and its low amount of debt are measured.

The question on the page originate from the summary of the following study material:

Malkiel: A random walk down Wallstreet

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