03rec9

03rec9 - 15.407 Recitation December 4 2003 MIT Sloan School...

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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 risk-free 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.

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03rec9 - 15.407 Recitation December 4 2003 MIT Sloan School...

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