6 figure the security market line sml the two

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Unformatted text preview: ses beta, the risk-free rate and the market return to define the required return on an investment Required return Beta for Risk-free Market = Risk-free rate + × − investment j return on investment j rate Capital Asset Pricing Model (CAPM) (cont’d) Pricing CAPM can also be shown as a graph Security Market Line (SML) is the “picture” of the CAPM Find the SML by calculating the required return for a number of betas, then plotting them on a graph Figure 5.6 Figure The Security Market Line (SML) The Two Approaches to Constructing Portfolios to Traditional Approach versus Modern Portfolio Theory Traditional Approach Traditional Emphasizes “balancing” the portfolio using a wide variety of stocks and/or bonds Uses a broad range of industries to diversify the portfolio Tends to focus on well­known companies – – – Perceived as less risky Stocks are more liquid and available Familiarity provides higher “comfort” levels for investors Modern Portfolio Theory (MPT) Modern Emphasizes statistical measures to develop a portfolio plan Focus is on: – – – Expected returns Standard deviation of returns Corre...
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