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Unformatted text preview: 15.407 Recitation December 4, 2003 MIT Sloan School of Management CAPM, APT and Capital Budgeting: Things to cover today: 1. Theory of CAPM 2. Theory of APT 3. Notes regarding Captial Budgeting CAPM: CAPM states that: E ( R i ) R f = β i ( E ( R m ) R f ) where β i = Cov ( R i ,R m ) V ar ( R m ) Compare to portfolio choice: E ( R i ) R f = β iT ( E ( R T ) R f ) What are the similarities and differences? • Both equations price all assets • Both equations use beta as a measure of risk • CAPM uses the market portfolio, PT uses the tangent portfolio • The key argument of CAPM is that the mar ket portfolio is the same as the tangent port folio, therefore everyone only holds the market portfolio and the riskfree asset. Application of CAPM: • Estimating risk: Market beta could be a more useful measure of risk than standard deviation of returns. • Estimating expected return of a assets: For example, it is hard to estimate the return of a stock using historical return, but beta could be estimated more precisely. Therefore it could be sensible to measure the beta of a stock and estimate its return using CAPM. You can also use CAPM to measure the cost of capital of a project • Evaluating fund performance: Estimate the beta of a fund. then calculate α i = R i R f...
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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.
 Fall '03
 Wang

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