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Econ 333
Spring 08
1
Portfolio Tools 4
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View Full Document Econ 333
Spring 08
2
Portfolio Tools 4
Our goals:
•
Understand the importance of meanstandard deviation diagram and know how to locate
within the diagram the efficient frontier of risky assets, the capital market line, the
minimum variance portfolio, and the tangency portfolio.
•
Compute and use both the tangency portfolio and the efficient frontier of risky assets.
•
Understand the linkage between meanvariance efficiency and riskexpected return
equations.
•
Describe how to compute the beat of a portfolio given the betas of individual assets in
the portfolio and their respective weights.
•
Understand what the market portfolio is, what assumptions are needed for the market
portfolio to be the tangency portfolio, i.e. for the Capital Asset pricing Model (CAPM)
to hold.
Econ 333
Spring 08
3
Portfolio Tools 4
•
The issue is that of analyzing the portfolio selection of an investor seeking to maximize the
expected return given the variance of its future returns.
•
As tools for illustrating how to achieve higher average returns with lower risk, meanvariance
analysis and the CAPM are routinely applied by brokers, pension fund managers, and
consultants when formulating investment strategies and giving financial advices.
•
A firm grasp of meanvariance analysis and the CAPM also is becoming increasingly important
for corporate managers. The need to understand the determinants of share value, and what
actions to take to increase this value in response to the pressures of stockholders and directors is
higher than ever before. They can apply these tools to hedge their risks optimally and diversify
their portfolio.
•
One of the lessons of the CAPM is that while diversifying investments can reduce the variance
of a firm’s stock price, it does not reduce the firm’s cost of capital (weighted average of the
expected rates of return required by the financial markets for a firm’s debt and equity financing).
•
As a result, diversification can create value only if it increases the expected returns of real assets.
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This note was uploaded on 04/01/2008 for the course ECON 3330 taught by Professor Mbiekop during the Spring '08 term at Cornell University (Engineering School).
 Spring '08
 MBIEKOP
 Economics

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