{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Lecture09c

# Lecture09c - Lecture 9 Capital Asset Pricing Model(CAPM 2...

This preview shows pages 1–5. Sign up to view the full content.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Lecture 9 Capital Asset Pricing Model (CAPM) 2 Efficient Frontier 14 22 10 17 Which portfolio would a risk averse investor choose? Standard Deviation Expected Return (%) A B C 3 Dominant Portfolios r We can safely assume that all rational investors will prefer A or B over C r That is, portfolio C is inefficient and is dominated dominated by A and B r However, the choice between A and B will depend on the investor’s risk preference r A more risk averse investor will prefer portfolio B to A 4 RisklessLending r Let us now assume that you can invest in portfolio A at 17%, as well as a risklessasset such as Treasury Bills at 4% (risk-free rate) r By investing in Treasury bills, you are effectively lending to the Federal Government 5 14 10 17 Adding the Risk-Free Asset 4 Standard Deviation Expected Return (%) risk-free asset 22 A B C Now assume that we can invest in a risk-free asset such as Treasury Bills at 4% (risk- free rate) 6 Standard Deviation Expected Return (%) RisklessBorrowing and Lending A 22 4 8.8 17 9.2 24.8 35.2 We could invest in a combination of the Risk Free Asset and A The range of portfolios lie on the straight line shown 7 Verify the point on the plot r Invest 40% in portfolio A and 60% in Treasury Bills r Expected return on your overall position = + E() E ) ) ( ( ff p A A r w w r r E()0.6(0.04)0.4(0.17) 0.092 9.2% p r = + = = 8 Verify the point on the plot r Variance of your overall position Std dev of risk free asset is zero 2 2 2 2 2 , 2 2 2 2 2 2 2 () 2 ()() p f f A A f A f A f A f A A f A A A A w w w w w w w w w σ σ σ ρ σ σ σ σ σ = + + = + + = σ σ σ σ σ σ = = = = = 2 2 2 0.4x0.22=0.088or8.8% p p A A A A p A A w w w 9 Weights must add to one RisklessBorrowing r Borrowing \$600 at the risklessrate, you can invest this together with your original wealth of \$1,000, a total of \$1,600, in portfolio A = ×- × ( 0.04)+( 0.17)=0.248 or 0.6 1.6 24.8% = + E() () E() p f f A A r wr w r r The standard deviation of your overall position is × 1.60.22=0.352or35.2% σ σ = = p A A w 10 Standard Deviation Expected Return (%) RisklessBorrowing and Lending A 22 4 8.8 17 9.2 24.8 35.2 Riskless Lending Riskless Borrowing 11 14 10 17 4 Standard Deviation Expected Return (%) risk-free asset 22 A B C We could also invest in the risk free asset and B 12 14 10 17 4 Standard Deviation Expected Return (%) risk-free asset 22 A C But we can do marginally better 13 The Capital Market Line Standard Deviation Standard Deviation Expected Return (%) 4% (r f ) Capital Market Line (CML) The line which runs at a tangent to the efficient frontier (from the risk-free return on the Y axis) is called the Capital Market Line (CML) Market Market Portfolio Portfolio What is Portfolio M? In theory the market portfolio contains every asset in the world. What is Portfolio M?...
View Full Document

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern