Class Note 7_F2011 - RSM 330 - Investments Class Note 7...

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RSM 330 - Investments Class Note 7 – November 3, 2011 Maureen Stapleton, CFA 1 RSM 330 - Week 8 Stapleton
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“Partners Healthcare” Case - Questions Think about the investment funds managed by Partners Healthcare’s Treasury Dept What type of funds are they? What is their size $$? What is the purpose of these funds? Who benefits from them? How are the funds currently invested? Is the performance of these funds important to the members of the Partners Healthcare System? Why or why not? What does Michael Manning want to achieve? What are his inputs? Do they make sense to you? What process does Manning use to explore alternatives? What are the results? What recommendation should Manning make ? Why? RSM 330 - Week 8 Stapleton 2
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Risk and Return CAPM answers two important questions How to measure risk? How to quantify the relationship between return and risk? CAPM has 3 important applications: Valuation Security selection Performance Measurement CAPM is based on modern portfolio theory (MPT) . Everyone holds a combination of the Market Portfolio & the riskless asset. Risk is the covariance of a risky asset with the market portfolio Expected return is linear with the covariance. RSM 330 - Week 8 Stapleton 3
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We’ll use the Market Portfolio in CAPM Remember from Week 4 & 5: Everyone holds a combination of the market portfolio and the riskless asset. It follows directly from the separation principle . Riskless borrowing and lending are offset in the aggregate portfolio. Standar d Deviatio n Expecte d Return R f Tangency portfolio = Market Portfolio CAL Optimal portfolios of individual investors 4 RSM 330 - Week 8 Stapleton The Slope of the CAL = Sharpe Ratio = p f p R R δ -
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Security Market Line (SML) Asset 1 Market Portfolio Asset 2 5 RSM 330 - Week 8 Stapleton Slope of SML= market risk premium
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Key Points about CAPM: The risk of a security is its covariance with the market portfolio. 6 RSM 330 - Week 8 Stapleton ) ( ) , ( M M i i r Var r r Cov = β The CAPM equation is: ( 29 f M i f i r r E r r E - = - ) ( ) ( Compensation for risk = amount of risk (β i ) x market price of risk (r M -r f ) Key Assumption of CAPM – only systematic risk is rewarded
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7 Important points: What are the intercept and the slope of SML? What are the differences between the Capital Allocation Line (CAL) versus Security Market Line (SML). Do you expect all securities to plot on the SML? By definition , - the Beta of the market is 1 - The Beta of the risk free asset is 0 The Security Market Line (SML) RSM 330 - Week 8 Stapleton
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8 A stock sells for $60 per share today. Suppose that the riskless rate is 7% over the next year, and the expected
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This note was uploaded on 12/20/2011 for the course RSM 330 taught by Professor Stapleton during the Fall '11 term at University of Toronto- Toronto.

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Class Note 7_F2011 - RSM 330 - Investments Class Note 7...

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