03rec9

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

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

15.407 Recitation December 4, 2003

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

View Full Document
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.

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

View Full Document
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 - β i ( R m - R f ). If α i > 0, then the fund is outperforming the market. Aver- age over time will yield sharper results.
This is the end of the preview. Sign up to access the rest of the 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