"41114_Midterm2_Review_handout-1

"41114_Midterm2_Review_handout-1 - Midterm 2...

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Course overview Sample problems Midterm 2 Review Session
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22 Midterm2: Tuesday, March 9 (PHYS114) Logistics: You have 1h 30 min Exam is closed book and closed notes (I will provide the formula sheet) Bring a calculator Others: Write answers on ‘answer page’ Don’t forget to sign out Show me your work so that I can give you partial credit
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33 Asset Pricing What explains differences in expected returns? -Traditional view: differences are completely explained by differences in risk. How do we measure risk? -We use standard deviation/variance. In addition, let’s assume that investors are mean-variance optimizers (i.e., they invest in a combination of the risk-free asset and the MVE portfolio b/c they realize that this gives them the highest Sharpe-Ratiox biggest “bang for the buck”)
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44 CAPM CAPM Assumptions: Investors are rational mean-variance optimizers Homogeneous expectations The market is in equilibrium Single-period investment horizon Individual investors are price takers No taxes and transaction costs All assets are investible In a related vein, we discussed ‘market equilibrium forces’ + ‘arbitrage’
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55 CAPM PREDICTION 1: Every investor would want to hold the same minimum-variance efficient portfolio + risk-free asset. The MVE must be the market portfolio in equilibrium! Best CAL = Capital Market Line : E ( r p ) = r f + [ E ( r M ) - r f ] σ M p
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If the simple CAPM is valid and all portfolios are priced correctly, is the following situation possible? (Assume the risk free rate is 5%.) 66 CAPM Portfolio E(r) StDev(r) A 10% 12% Market 15% 20%
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"41114_Midterm2_Review_handout-1 - Midterm 2...

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