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# Ch24 Show - Chapter 24 Portfolio Theory Asset Pricing...

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1 Chapter 24 Portfolio Theory, Asset  Pricing Models, and  Behavioral Finance

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2 Topics in Chapter n Portfolio Theory n Capital Asset Pricing Model (CAPM) n Efficient Frontier n Capital Market Line (CML) n Security Market Line (SML) n Beta calculation n Arbitrage pricing theory n Fama-French 3-factor model
3 Value =                         +                         +     + FCF1 FCF2 FCF∞ (1 + WACC)1 (1 + WACC)∞ (1 + WACC)2 Free cash  flow (FCF) Market interest rates Firm’s business risk Market risk aversion Firm’s debt/equity mix Cost of debt Cost of equity Weighted  average cost of capital (WACC) Net operating profit after  taxes Required  investments in operating capital = Determinants of Intrinsic Value: The Cost of Equity ...

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4 Portfolio Theory n Suppose Asset A has an expected return of  10 percent and a standard deviation of 20  percent.  Asset B has an expected return of  16 percent and a standard deviation of 40  percent.  If the correlation between A and B is  0.35, what are the expected return and  standard deviation for a portfolio comprised of  30 percent Asset A and 70 percent Asset B?
5 Portfolio Expected Return r p = w A r A + (1 – w A ) r B ^ ^ ^ = 0.3(0.1) + 0.7(0.16) = 0.142 = 14.2%.

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6 Portfolio Standard Deviation σP = w2Aσ2A + (1-wA)2σ2B + 2wA(1- wA)ρABσAσB = 0.32(0.22) + 0.72(0.42) + 2(0.3)(0.7)(0.35)(0.2)(0.4) = 0.306
7 Attainable Portfolios: rAB = 0.35 ρ AB = +0.35: Attainable Set of Risk/Return Combinations 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% Risk, σ p Expected return

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8 Attainable Portfolios: rAB = +1 ρ AB = +1.0: Attainable Set of Risk/Return Combinations 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% Risk, p Expected return
9 Attainable Portfolios: rAB = -1 ρ AB = -1.0: Attainable Set of Risk/Return Combinations 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% Risk, σ p Expected return

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Attainable Portfolios with Risk-Free Asset  (Expected risk-free return = 5%) Attainable Set of Risk/Return Combinations with Risk-Free Asset 0% 5% 10% 15% 0% 5% 10% 15% 20% Risk, σ p Expected return
11 Expected Portfolio Return, rp Risk, σ π Efficient Set Feasible Set Feasible and Efficient  Portfolios

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12 Feasible and Efficient  Portfolios n The feasible set of portfolios represents all  portfolios that can be constructed from a  given set of stocks. n An efficient portfolio is one that offers: n the most return for a given amount of risk, or n the least risk for a give amount of return. n The collection of efficient portfolios is called  the efficient set or efficient frontier.
13 IB2 IB1 IA2 IA1 Optimal Portfolio Investor A Optimal  Portfolio Investor B Risk  σ p Expected Return, rp Optimal Portfolios

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14 Indifference Curves n Indifference curves reflect an investor’s  attitude toward risk as reflected in his or  her risk/return tradeoff function.  They
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## This note was uploaded on 02/27/2012 for the course BUS 510 taught by Professor Mehdi during the Spring '11 term at University of La Verne.

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Ch24 Show - Chapter 24 Portfolio Theory Asset Pricing...

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