F420-7 - The Capital Asset Pricing Model Click to edit...

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Click to edit Master subtitle style BUS-F420 The Capital Asset Pricing Model February 3, 2011
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Agenda: Today: CAPM Tuesday 2/8: APT and Multifactor Models Thursday 2/10: Review for Midterm 1 Tuesday 2/15: Midterm 1 Thursday 2/24: Case 2 – Dimensional Fund Advisors (Questions at end of Thursday’s lecture) Announcements
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For Midterm: Will post a practice midterm (and solutions) Answers to select problems from Chapters 5, 7, 9, 10, 25 are now on ONCOURSE Announcements
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It is the equilibrium model that underlies all modern financial theory Derived using principles of diversification with simplified assumptions Markowitz, Sharpe, Lintner and Mossin are researchers credited with its development Capital Asset Pricing Model (CAPM)
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1. Individual investors are price takers Small investors Trades don’t move markets Perfect competition 2. Single-period investment horizon Short-sighted (myopic) behavior 3. Investments are limited to traded financial assets No private assets, human capital, governmentally funded assets Also investors can lend and borrow at fixed risk- free rate Assumptions
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4. No taxes and transaction costs Also implies liquid markets Information is costless and available to all investors 5. Investors are rational mean-variance optimizers Use Markowitz portfolio selection model 6. There are homogeneous expectations Investors all use the same inputs Assumptions (continued)
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In this assumed (and admittedly unrealistic) world, here is what will happen: 1. All investors will hold a portfolio of risky assets in proportions that duplicate that of the market portfolio, M This includes ALL traded securities – not just stocks, but we will generally refer to stocks. The proportion of each security is its market
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This note was uploaded on 02/07/2011 for the course BUS-F 420 taught by Professor Israelison during the Spring '11 term at Indiana.

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F420-7 - The Capital Asset Pricing Model Click to edit...

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