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Principles of finance ah la shmoop waited averages and expectations

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Alright us oddsmakers a big theme in finance What do

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you believe The odds are that your body will pay

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back the loan you just made her What do you

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believe The odds are that you'll get into a car

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accident on the way home from dinner tonight What are

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the odds that this drug cures cancer instead of just

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you know making hair grow on your knuckles Well you're

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going away odds and give numbers when you calculate outcomes

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The big challenge here bias if you ask ten thousand

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varsity all star high school basketball players in the u

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s iea about all of the all stars what they

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think the odds are that they will turn pro and

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play in the n b a We guess about twenty

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percent of them will say fifty fifty So what is

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that number impute Well it means that half of the

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twenty percent or ten percent will turn pro and play

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in the n b a That means that based on

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your sample ten percent of ten thousand or one thousand

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varsity all star high school basketball players in the u

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s just this year will turn pro and play in

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the n b a And given that there are only

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about five hundred total players in the n b a

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it would be truly striking if more than double that

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number in a single year ended up being on the

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floor Yeah so what's the problem here Yes biased high

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school athletes are knuckleheads when it comes to separating reality

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from dream don't you wish you still had that love

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in your life All right well the reality here is

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that in a given year about ten high school students

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who play varsity all star hoops actually make it into

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the n b a and play for a little bit

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in the pros The odds are good that if you

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put all your eggs in the pro basketball basket well

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it won't end well See the section of shmoop that

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covers careers as a high school basketball coach physical trainer

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and uber driver and delivering pizza Teo you know pay

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your rent all rights let's hang up our sneakers for

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now and think through an investment case being a rap

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star who actually makes meaningful money comes with about the

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same odds as being a successful n ba player But

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at least in the n b a you make serious

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money and for more than just the one or two

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years But we're not here to give career advice per

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se So let's start by looking at the numbers here

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looking an album here and what the album does All

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right so we have a rapper's album That's gonna have

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different outcomes Different levels of goodness Different levels of money

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Note here that the odds have tto add up to

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one hundred percent You have to have invested your dough

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fully there So these numbers are kind of odd Your

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odds adjusted financial return here investing in this rappers album

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everything here's the man You all right You know they're

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they're here Well should you fund this album you get

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fifty two percent What do these numbers mean anyway The

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data is saying that the most likely outcome is that

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you make just over half your money back So why

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on earth would you put in a dollar when the

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most likely outcome is that you get fifty two and

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a half cents back in years later Well with an

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expected return Less than one note how we conveniently ignored

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time value here like you held it for five years

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in an index fund I almost double your money or

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at least get closed All right Well this investment on

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this rap album is an easy pass So then what

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would not be an easy past kind of investment Like

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what Hurdle rate Yes hurdle rate Would you need tohave

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that's greater than one that would then tickle your fancy

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to find your pen and sign your john hancock and

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take your hard earned money and invest it Ignoring time

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is dangerous There we'll come back to that All right

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well but in this case what if we believed in

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america capitalism standing in respect for the flag An apple

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pie Well if that's the case then we've comfortably invest

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in stock market and hold for long periods of time

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like just buying index fund and go play golf So

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let's believe that the market in this era will go

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up about ten percent a year We still really want

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to be an investor in the entertainment biz and rap

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albums you know because our self esteem is low and

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we need the hottie bling to make us feel special

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What multiple of our investment do we need to recoup

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in order to meaningfully beat our and percent a year

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hurdle rate in five years Well we start with the

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base case of the market And if we invest a

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dollar today than in five years it should be a

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dollar times one point one of the fifth power or

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about a buck sixty Well how can we make the

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outcome of our rap album investment mohr likely positive Well

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what if we cut a nice distribution deal with read

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it Who guaranteed us five hundred a emma's a week

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for a month You know that tickle people's fancy give

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us distribution awareness Maybe a little brand Well then all

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of a sudden the likelihood of the album being a

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hit goes way way up in the new tables Look

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like this Yeah And the album's not gonna kill people

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here right here in the Numbers in the 1:3 5 there

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we go all right well note that a few things

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changed with the red it guys now marketing us well

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the odds of the album inspiring young people that actually

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do bad stuff went down The high end went higher

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We make five times our money for a chart topper

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instead of three times And the odds of just getting

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half our dough back went down slightly Well here's the

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new expected return You here's the math We're gonna win

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one point a point You have five minutes Use all

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the odd close but no cigar will be expected Return

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on this investment in five years is one point three

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five acts But in order to drive a ten percent

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return well we need one point Six x or mohr

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And remember investing in the stock markets probably a whole

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lot less risky and investing in a rap album Well

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what if the investment happened over a three year timeframe

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I eat The album was produced and distributed much faster

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instead of that five year plan Wealth than our new

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hurdle rate is one point one two the third day

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at one point three three that's kind on the market

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would compound their magic Well in this case the expected

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return on the rap album is just slightly better than

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out of the stock market That is one point three

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Five Acts beats 1 . 3 3 at least in america so should

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you invest is the rap album a better deal than

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just buying an index fund of the s and p

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five hundred no in oh absolutely not even though mathematically

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you have calculated above that it is well why risk

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note the volatility in the rap album scenario you have

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seventy percent odds that you lose half your money you

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have ten percent odds you lose all your money and

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maybe go to jail as well among other life negating

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issues you only have a twenty percent shot of making

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five times your money in three years and by the

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way if you like playing the lottery that way well

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there are tons of public company stocks that go up

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five times in three years all the time if you

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just go bet on those now consider the stock market

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scenario what are the odds the market ends up being

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worth zero well that would mean the world's been fully

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nuked and there are no humans left including you so

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you'd have other things to worry about him that were

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the case or actually you'd have nothing to worry about

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because you just be well dead or a zombie or

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something And what are the odds of the market going

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down Fifty percent Well in all history the market hasn't

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had that size correction but twice and it came off

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ridiculous bubble highs highs everyone knew were crazy and the

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correction didn't even last very long But remember the one

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hundred times revenues multiples late nineteen nineties internet boom Yeah

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that kind of crazy that's what we're talking about here

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So the odds of the market being cut in half

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are awfully low but even if it was in your

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patient five years later it would likely have recovered teo

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just being flat So what's ah five year old rap

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album worth Yeah not a lot Well the concept we're

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getting at here is called beta beta is the standard

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by which enormous investment decisions are made in veda is

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contacts you'll meaning that it means something different two different

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people think of it as the religion of risk Well

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let's quantify some elements and newsome dissection of beta there

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Alright what's odd about the rap album situation is that

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the numbers are extreme in their variability like you either

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Spend your life doing open mic nights or you open

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for m and m Yeah them so far ends of

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the spectrum Enormous deviation or standard deviation among outcomes Yes

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we're reviewing from your stats course here people But we

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need thio further review here's set of Numbers a 15:14 18

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bhola blossom Numbers b 0:3 58 one twelve alright guess what

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a is and guess what he is waiting waiting okay

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a is what a portfolio of seven publicly traded stocks

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did in a bullish market over the course of two

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years and v is what a venture capital portfolio did

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over the same time period note how much more variable

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the venture investments were a bunch of them went fully

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bankrupt that's what zeroes mean and in one you'd have

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made a one hundred twenty five times your money in

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two years yeah nice work if you can get it

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well the public set of stocks was relatively low beta

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and the private investments were very high beta mathematically most

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investors think about beta as performance relative to the market

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and when they say market it's a fair question to

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ask which market and when we say market around here

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we think of the standard as being the s and

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p five hundred But if you're talking about tech stocks

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while most people think about nasdaq as the market okay

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how about a super simple example definition of beta here

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Well yes and p five hundreds of twenty thousand It

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goes up ten percent in a year and it ends

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up twenty two thousand Your ten dollars stock in boring

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co a drilling company not an emotional delimiting company ends

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its urine eleven dollars it's beta relative to the s

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and p five hundred is one meaning for each unit

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that the market moved up Your sir stock moved up

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the same amount But you have another stock in your

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portfolio called snort mongers a chain of comedy clubs that

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serves super foamy root beer So when audiences laugh it

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shoots out of their nurses Uh well the public fell

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in love with this chain and its stock went from

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forty bucks a share Two fifty two bucks went up

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thirty percent beta three Well it moved three times as

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much as did the market in that year So don't

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listen A weight lifters jocks or bro's about how important

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It is to be alfa The real winners here know

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that beta is where you reach the cash and think

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really hard before you invest in that rap album from

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your crazy uncle larry he's Not really a cz good 00:10:42.977 --> [endTime] as he thinks he is

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