ch13 - The Capital Asset Pricing Model Model(CAPM Yihui...

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The Capital Asset Pricing odel (CAPM) Model (CAPM) h t 13 -- Chapter 13 ihui Wang Yihui Wang The Capital Asset Pricing Model (CAPM)
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Main Issues • Review on statistics and probability • Expected return and volatility for securities • Portfolios and diversification • Risk: systematic and unsystematic • Beta and the security market line •T h e C a pital Asset Pricing Model (CAPM) The Capital Asset Pricing Model (CAPM) 2
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Random Variables • What is a random variable? = = H X ω , 0 ) ( = T , 1 The Capital Asset Pricing Model (CAPM) 3
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Mean and Variance of Random Variables The Capital Asset Pricing Model (CAPM) 4
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ovariance and Correlation Covariance and Correlation The Capital Asset Pricing Model (CAPM) 5
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Correlation The Capital Asset Pricing Model (CAPM) 6
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Important Properties The Capital Asset Pricing Model (CAPM) 7
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Return and Random Variables eturn on an asset is a ndom variable aracterized by Return on an asset is a random variable, characterized by all possible outcomes R i probability of each outcome (state) p i Suppose you have predicted the following returns for stocks C and T in three possible states of nature. State Probability C T 3 Boom 0.3 15 25 Normal 0.5 10 20 Recession ??? 2 1 What is the probability of recession? What are the expected returns of stock C and T? If risk-free rate is 6.15%, what is the risk premium? The Capital Asset Pricing Model (CAPM) What are the variance and standard deviation? 8
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Standard Deviation and Risk • Variance and standard deviation measure how volatile the return can be • Standard deviation is σ , it’s a measure of risk in finance, called volatility •W hich of the following three assets will you choose? The Capital Asset Pricing Model (CAPM) 9
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Standard Deviation and Risk The Capital Asset Pricing Model (CAPM) 10
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Portfolios • A portfolio is a collection of assets • An asset’s risk and return are important in how they affect the risk and return of the portfolio • The risk-return trade-off for a portfolio is measured by the portfolio expected return and standard deviation, just as with individual assets f l i i h f l h i d i • Portfolio weight: percentage of wealth invested in each asset The Capital Asset Pricing Model (CAPM) 11
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Example: Portfolio Weights • Suppose you have $15,000 to invest and you have purchased securities in the following amounts. What fl i ih i h i ? are your portfolio weights in each security? $2000 of DCLK 000 of KO •DCLK: 2/15 = .133 O 3/15 = 2 $3000 of KO $4000 of INTC $6000 of KEI •KO: 3/15 = .2 •INTC: 4/15 = .267 EI: 6/15 = .4 $ KEI: 6/15 .4 The Capital Asset Pricing Model (CAPM) 12
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Return and Standard Deviation of Portfolios: Example • You invest $400 in stock X and $600 in stock Y State Recession Normal Boom Probability 0.2 0.6 0.2 Stock X (%) -5 10 20 ock Y (%) 0 0 What is the expected return of your portfolio?
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This note was uploaded on 02/16/2011 for the course ACCT 233 taught by Professor 123 during the Spring '11 term at CUHK.

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ch13 - The Capital Asset Pricing Model Model(CAPM Yihui...

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