1. CAPM - r i = ∆ r M ⇒ risk i = risk M ⇒ r i = r M...

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“Low Risk Stock” Risk Premium Market Risk Premium = r M - r RF Risk-Free Rate, r RF SML: r i = r RF + ß( RP M ) ”High Risk Stock” Risk Premium Required Rate of Return (%) Security Market Line (SML) r H r M r L r RF ß L 1 ß H ß (Risk) Capital Asset Pricing Model (CAPM) r i = r RF + ß i (r M - r RF ) • ß i = σ iM / σ M 2 r i - r RF = ß i (r M - r RF ) • ß i = r i / r M • ß i > 1 r i > r M risk i > risk M r i > r M • ß i < 1 r i < r M risk i < risk M r i < r M • ß i = 1 r
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Unformatted text preview: r i = ∆ r M ⇒ risk i = risk M ⇒ r i = r M • ß M = 1 n • portfolio ß = ß p = ∑ w i ß i i=1 • the portfolio ß is the weighted average of the individual ß’s, using percentage of portfolio value as weights Shift in the SML Caused by an Increase in Inflation (k = r) Shift in the SML Caused by Increased Risk Aversion...
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