Lecture_11spring

Lecture_11spring - Lecture 11 Review of CAPM Single I ndex...

Info iconThis preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Lecture 11 Review of CAPM Single I ndex Model 1 CAPM-what is it? CAPM predicts the relationship between the expected return on the security and its risk Beta a measure of the assets covariance with the overall market- is the correct measure of risk for any asset The market portfolio is the common risky portfolio (One Mutual Fund theorem) that all investors hold CAPM The fair risk premium on asset i: Define the assets beta as the contribution of the stock i to the variance of the market portfolio Finally we obtain: ] ) ( [ ) , ( ) ( 2 f m m m i f i r r E r r Cov r r E- =- 2 ) , ( m m i i r r Cov = ] ) ( [ ) ( f i f i r r E r r E m- =- 01 . * ) , ( } { A r r Cov r r E m i f i =- Security Market Line SML exhibits the expected return beta relationship: SML graphs the individual asset risk premiums as a function of asset risk (beta). Given the risk of an investment, SML provides the required rate of return for that investment. Slope is equal to the risk premium of the market portfolio. 4 M Security Market Line SML exhibits the expected return beta relationship: Fairly priced assets would be located exactly on the SML. I f a stock is a good buy (i.e. underpriced), it would provide an expected return in excess of the fair return described by the SML. positive alpha stocks are a good buy 5 Security Market Line Notice, if alpha > 0, everyone wants to buy Notice, if alpha < 0, everyone wants to sell Hence price is not in equilibrium unless alpha = 0 6 Risk pr emium on an individual asset is pr opor tional to the r isk pr emium on mar ket por tfolio and the secur ity's beta. E{r e }- r f = e [E{r m } - r f ] This r elationship defines the Secur ity M ar ket Line I mplications of the Capital Asset Pr icing M odel 1 Security Market Line . r f E{r} E{r m } Slope = E{r m } - r f 2 ) , ( m m e e r r Cov = I mplications of the Capital Asset Pr icing M odel Risk pr emium on an individual asset is pr opor tional to the r isk pr emium on mar ket por tfolio and the secur ity's beta. E{r e }- r f = e [E{r m } - r f ] This r elationship defines the Secur ity M ar ket Line Suppose r f = 5%, e = 0.5, and the mar ket r isk pr emium (E{r m } - r f ) is 8%. Fill out the missing values 1 Security Market Line ? E{r} ? Slope = E{r m } - r f 0.5 ? I mplications of the Capital Asset Pr icing M odel Risk pr emium on an individual asset is pr opor tional to the r isk pr emium on mar ket por tfolio and the secur ity's beta. E{r e }- r f = e [E{r m } - r f ] This r elationship defines the Secur ity M ar ket Line Suppose r f = 5%, e = 0.5, and the mar ket r isk pr emium (E{r m } - r f ) is 8%....
View Full Document

Page1 / 60

Lecture_11spring - Lecture 11 Review of CAPM Single I ndex...

This preview shows document pages 1 - 10. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online