{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

capm_overhead - CAPM 1 CAPM Introduction to CAPM The CAPM...

Info icon This preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
CAPM 1 CAPM Introduction to CAPM The CAPM has a variety of uses: It provides a theoretical justification for the widespread practice of “passive” investing known as indexing . Indexing means holding a portfolio similar to a broad market index such as the S&P 500. * Individual investors can just buy an index fund .
Image of page 1

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

View Full Document Right Arrow Icon
CAPM 2 CAPM can provide estimates of expected rates of return on individual investments Estimates based on the mean of historic time series are known to be inaccurate * the problem is lack of enough data So alternative estimates are useful CAPM can establish “fair” rates of return on invested capital in regulated firms or in firms working on a cost-plus basis what should the “plus” be?
Image of page 2
CAPM 3 CAPM starts with the question, what would be the risk premiums on securites if the following assumptions were true? The market prices are “in equilibrium.” In particular, for each asset, supply equals demand. Everyone has the same forecasts of expected returns and risks.
Image of page 3

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

View Full Document Right Arrow Icon
CAPM 4 All investors chose portfolios optimally according to the priniciples of efficient diversification. This implies that everyone holds the tangency portfolio of risky assets as well as the risk-free asset. * only the mix of the tangency portfolio and the risk-free varies between investors
Image of page 4
CAPM 5 The market rewards people for assuming unavoidable risk, but there is no reward for needless risks due to inefficient portfolio selection. Therefore, the risk-premium on a single security is not due to its “stand alone” risk, but rather to its contribution to the risk of the tangency portfolio. * The various components of risk will be discussed later. “Return” can either refer to one-period net returns or one-period log returns.
Image of page 5

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

View Full Document Right Arrow Icon
CAPM 6 Suppose there are three assets with a total market value of $100 billion. Stock A: $60 billion Stock B: $30 billion risk-free: $10 billion
Image of page 6
CAPM 7 The market portfolio of Stock A to Stock B is 2:1. CAPM says that under equilibrium, all investors will hold Stock A to Stock B in a 2:1 ratio. Therefore, the tangency portfolio puts weight 2/3 on Stock A and 1/3 on Stock B all investors will have two-thirds of their allocation to risky assets in Stock A and one-third in Stock B.
Image of page 7

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

View Full Document Right Arrow Icon
CAPM 8 Suppose there was too little of Stock A and too much of Stock B for everyone to have a 2:1 allocation. For example, assume: one million shares of each stock and the price per share was $60 for Stock A and $40 for Stock B. Then the market portfolio must hold Stock A to Stock B in a 3:2 ratio, not 2:1. Not everyone could hold the tangency portfolio.
Image of page 8
CAPM 9 Prices would be in disequilibrium and would change. The price of Stock A would go up.
Image of page 9

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

View Full Document Right Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    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.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    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.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    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.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern