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slides11 - 11 CAPM(continued In these slides we go into...

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11. CAPM (continued) In these slides, we go into more detail about the CAPM , including a discussion of the efficient frontier .
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Getting started... Begin by reviewing the first several slides from the previous lecture. Recall that we supposed the existence of two possible assets avail- able to invest in, A and B : the expected return of A is E ( R A ) and the standard devia- tion is σ A . the expected return of B is E ( R B ) and the standard devia- tion is σ B . the correlation between the returns of A and B is ρ . The portfolio with weights w A invested in asset A and w b invested in asset B has expected return E ( R p ) = w A E ( R A ) + w B E ( R B ) and variance σ 2 p = w 2 A σ 2 A + w 2 B σ 2 B + 2 w A w B ρσ A σ B 2
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Draw figure of feasible set with two assets. 3
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Constructing portfolios — continued Now let’s expand the set of possible assets. Suppose there are n risky assets. Risky asset i has expected return E ( R i ) and standard deviation σ i , and the correlation between assets i and j is ρ ij . Suppose we form a portfolio with fraction w i of our invest- ment in asset i where n i =1 w i = 1 . Then E ( R p ) = n summationdisplay i =1 w i E ( R i ) and σ 2 p = n summationdisplay i =1 n
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