lecture 1 - Investment & Securities Markets Lecture 1...

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Investment & Securities Markets Lecture 1 Asset Pricing Models (1) Andy Adams
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ASSET PRICING MODELS (1) • Capital Asset Pricing Model (CAPM) • Testing the CAPM • Implications
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ASSUMPTIONS FOR CAPM 1. All investors are risk-averse and measure risk in terms of standard deviation of portfolio return (as for the Markowitz Model). 2. All investors have a common time horizon for investment decision-making (eg one month or two years). 3. All investors have identical subjective estimates of future returns and risks for all assets. 4. There exists a risk-free asset and all investors may borrow or lend unlimited amounts at the risk-free rate. 5. All assets are completely divisible, there are no transaction costs or differential taxes, and there are no restrictions on short-selling. 6. Information is freely and simultaneously available to all investors.
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ESTIMATING BETA R i α i R m β i
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SECURITIES MARKET LINE gives a direct relationship between expected return and beta value. E(R i ) = R f + β i {E(R m ) - R f } E(R i ) = Expected return on share i R f = Risk-free rate β i = Beta of share E(R m )= Expected return on market This is the main result of the Capital Asset Pricing Model.
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IN DIAGRAM FORM: SECURITIES MARKET LINE 1 () i R E () m R E f R i β
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IN TESTING THE CAPM (1) • CAPM is stated in terms of investor expectations
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This note was uploaded on 04/03/2008 for the course MSE ISM taught by Professor Andrewadams during the Fall '07 term at University of Edinburgh.

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lecture 1 - Investment & Securities Markets Lecture 1...

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