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ch09 - 9-1 Lecture IV Chapter 9(7th/8th/9th edition Capital...

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9-1 Lecture IV Chapter 9 (7 th /8 th /9 th edition) 9-2 Lecture IV – p.2 FIN 6275 It is the equilibrium model that underlies all modern financial theory. Derived using principles of diversification with simplified assumptions. Markowitz, Sharpe, Lintner and Mossin are researchers credited with its development. Capital Asset Pricing Model (CAPM) 9-3 Lecture IV – p.3 FIN 6275 Assumptions Individual investors are price takers Single-period investment horizon Investments are limited to traded financial assets No taxes and transaction costs Information is costless and available to all investors Investors are rational mean-variance optimizers There are homogeneous expectations
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9-4 Lecture IV – p.4 FIN 6275 1) All investors will hold the same portfolio for risky assets – market portfolio. 2) Market portfolio contains all securities and the proportion of each security is its market value as a percentage of total market value. Resulting Equilibrium Conditions 9-5 Lecture IV – p.5 FIN 6275 3) Risk premium on the the market depends on the average risk aversion of all market participants. 4) Risk premium on an individual security is a function of its covariance with the market. Resulting Equilibrium Conditions (cont’d) 9-6 Lecture IV – p.6 FIN 6275 1) Capital Market Line E(r) E(r M ) r f M CML σ m σ Common portfolio due to homogeneous expectations‘ Mutual Fund Theorem’ = Separation Property Passive Investment is efficient
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9-7 Lecture IV – p.7 FIN 6275 M = Market portfolio r f = Risk free rate E(r M ) - r f = Market risk premium E(r M ) - r f = Market price of risk = Slope of the CML CML is the CAL of the Market portfolio M σ Slope and Market Risk Premium 9-8 Lecture IV – p.8 FIN 6275 If Investors would like to hold more shares of IBM than currently available.
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