03finalreview

03finalreview - Time Value of Money • Theory of Real...

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Unformatted text preview: Time Value of Money • Theory of Real Interest Rates – Two-period r = 1 ρ- 1 ! + 1 ρ - c u 00 ( c ) u ( c ) d c c ! – Multi-period r t = ρ- t u ( c ) E[ u ( c t )]- 1 • Term Structure Hypothesis – Expectation Hypothesis – Liquidity Preference Hypothesis 1 Portfolio Theory • Portfolio – Weights w i X i w i = 1 – Expected return r p = X i w i r i – Variance σ 2 p = X i X j w i w j σ ij • Diversification – Systematic risk – Non-systematic risk • Optimal Portfolio Selection – Objective * minimize variance given expected return – Portfolio frontier with only risky assets – Portfolio frontier with risky and riskless assets * Tangent portfolio * Implication r i- r f = σ iT σ 2 T ( r T- r f ) 2 CAPM • Derivation – Foundations of portfolio theory – Market clearing • Implication E( r i )- r f = β i (E( r m )- r f ) • Measuring CAPM coefficients ˜ r i- r f = α i + β i (˜ r m- r f ) + ˜ i – β i , measure of systematic risk – α , zero according to CAPM – statistical significance – , measure of idiosyncratic risk – R 2 , how much variance can be explained by market risk • Leverage β A = D D + E β D + E D + E β E • Pros and Cons 3 Arbitrage Pricing Theory • Model ˜ r i = E( r i ) + b i 1 ˜ f 1 + ... + b ik ˜ f k + ˜ u i • Implication E( r i )- r f = b i 1 (E( F 1 )- r f ) + ... + b ik (E( F k )- r f ) • Pros and Cons Efficient Market Hypothesis • Weak form • Semi-strong form • Strong form • Evidence 4 Capital Budgeting • NPV Rule – Invest if NPV is positive • Cash flow calculation...
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This note was uploaded on 01/19/2011 for the course 15 15.407 taught by Professor Wang during the Fall '03 term at MIT.

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03finalreview - Time Value of Money • Theory of Real...

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