# L5 - Lecture 5 Capital Asset Pricing Model 5-2 Key Concepts...

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Lecture 5 Capital Asset Pricing Model

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5-2 Key Concepts and Skills Understand variance as a measure of total risks Understand the modern portfolio theory Understand Capital asset pricing model (CAPM) Know how to calculate expected returns based on CAPM
5-3 Lecture outline Returns of individual assets and risks of individual assets. Returns of portfolios and risks of portfolios Traditional Portfolio Theory Modern Portfolio Theory Betas of individual assets Betas of portfolios Security Market Line Capital Asset Pricing Model

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5-4 Returns The simplest measure of return is the holding period return . Holding period = return Ending Beginning value value Income Beginning value _ +
5-5 Buy 100 shares at \$25 per share Time Sell the shares at \$30 per share Dividend of \$0.10 per share Example : Holding period return = = 20.4% \$30 - \$25 + \$0.10 \$25 Holding Period Return

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5-6 Calculating Returns -- Example You bought a stock for \$35 and you received dividends of \$1.25. The stock is now selling for \$40. What is your dollar return? What is your percentage return?
5-7 Risk A common measure of risk is variance . The standard deviation is the square root of the variance. ( 29 2 1 n i i R R Variance n = - =

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Stock A Stock B 2000 1% 6% 2001 9% 4% 2002 8% 6% 2003 1% 7% 2004 9% 3% 2005 2% 4% Average 5% 5%
0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 2000 2001 2002 2003 2004 2005 VOLATILITY STOCK A STOCK B

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Stock A Stock B 2000 1% 6% 2001 9% 4% 2002 8% 6% 2003 1% 7% 2004 9% 3% 2005 2% 4% Average Return 5% 5% Variance 0.00164 0.00024
5-11 Portfolios A portfolio is a collection of assets The portfolio’s return is the weighted average of the returns for each asset in the portfolio Compute the

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