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Unformatted text preview: 81The Capital Asset Pricing Model•A Conceptual Development of the CAPM–The existence of a riskfree asset resulted in deriving a capital market line (CML) that became the relevant frontier–However, CML cannot be used to measure the expected return on an individual asset–For individual asset (or any portfolio), the relevant risk measure is the asset’s covariance with the market portfolio–That is, for an individual asset i, the 82The Capital Asset Pricing Model–Applying the CML using this relevant risk measure–Let βi=(σi riM) / σM be the asset beta measuring the relative risk with the market, the systematic risk –The CAPM indicates what should be the expected or required rates of return on risky assets]E(R[rRFR)E(RMiMiMiRFRσσ+=)])[RFRi+=MiE(RRFR)E(Rβ83The Capital Asset Pricing Model•The Security Market Line (SML)–The SML is a graphical form of the CAPM–Exhibit 8.5 shows the relationship between the expected or required rate of return and the systematic risk on a risky asset –The expected rate of return of a risk asset is determined by the RFR plus a risk premium for the individual asset–The risk premium is determined by the systematic risk of the asset (beta) and the prevailing market risk premium (RMRFR)84Exhibit 8.585...
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This note was uploaded on 01/24/2012 for the course FIN 4360 taught by Professor Davidbray during the Spring '12 term at Kennesaw.
 Spring '12
 DAVIDBRAY
 Capital Asset Pricing Model

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