FM8e- ch03 - 3-1 CHAPTER 3 Risk and Return: Part II Capital...

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3 - 1 CHAPTER 3 Risk and Return: Part II Capital Asset Pricing Model (CAPM) Efficient frontier Capital Market Line (CML) Security Market Line (SML) Beta calculation Arbitrage pricing theory Fama-French 3-factor model
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3 - 2 What is the CAPM? The CAPM is an equilibrium model that specifies the relationship between risk and required rate of return for assets held in well- diversified portfolios. It is based on the premise that only one factor affects risk. What is that factor?
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3 - 3 Investors all think in terms of a single holding period. All investors have identical expectations. Investors can borrow or lend unlimited amounts at the risk-free rate. What are the assumptions of the CAPM? (More. ..)
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3 - 4 All assets are perfectly divisible. There are no taxes and no transactions costs. All investors are price takers, that is, investors’ buying and selling won’t influence stock prices. Quantities of all assets are given and fixed.
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3 - 5 Expected Portfolio Return, r p Risk, σ p Efficient Set Feasible Set Feasible and Efficient Portfolios
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3 - 6 The feasible set of portfolios represents all portfolios that can be constructed from a given set of stocks. An efficient portfolio is one that offers: the most return for a given amount of risk, or the least risk for a give amount of return. The collection of efficient portfolios is called the efficient set or efficient frontier.
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3 - 7 I B 2 I B 1 I A 2 I A 1 Optimal Portfolio Investor A Optimal Portfolio Investor B Risk σ p Expected Return, r p Optimal Portfolios
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3 - 8 Indifference curves reflect an investor’s attitude toward risk as reflected in his or her risk/return tradeoff function. They differ among investors because of differences in risk aversion. An investor’s optimal portfolio is defined by the tangency point between the efficient set and the investor’s indifference curve.
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3 - 9 When a risk-free asset is added to the feasible set, investors can create portfolios that combine this asset with a portfolio of risky assets. The straight line connecting r
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This note was uploaded on 08/29/2009 for the course FM Finance taught by Professor Unknown during the Spring '09 term at DeVry Addison.

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FM8e- ch03 - 3-1 CHAPTER 3 Risk and Return: Part II Capital...

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