FM11 Ch 05 Show - CHAPTER 5 5-1 Risk and Return Portfolio Theory and Asset Pricing Models Portfolio Theory Capital Asset Pricing Model(CAPM Efficient

# FM11 Ch 05 Show - CHAPTER 5 5-1 Risk and Return Portfolio...

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5 - 1 CHAPTER 5 Risk and Return: Portfolio Theory and Asset Pricing Models Portfolio Theory Capital Asset Pricing Model (CAPM) Efficient frontier Capital Market Line (CML) Security Market Line (SML) Beta calculation Arbitrage pricing theory Fama-French 3-factor model
5 - 2 Portfolio Theory 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 0.6, what are the expected return and standard deviation for a portfolio comprised of 30 percent Asset A and 70 percent Asset B?
5 - 3 Portfolio Expected Return %. 2 . 14 142 . 0 ) 16 . 0 ( 7 . 0 ) 1 . 0 ( 3 . 0 r ˆ ) w 1 ( r ˆ w r ˆ B A A A P = = + = - + =
5 - 4 Portfolio Standard Deviation 309 . 0 ) 4 . 0 )( 2 . 0 )( 4 . 0 )( 7 . 0 )( 3 . 0 ( 2 ) 4 . 0 ( 7 . 0 ) 2 . 0 ( 3 . 0 ) W 1 ( W 2 ) W 1 ( W 2 2 2 2 B A AB A A 2 B 2 A 2 A 2 A p = + + = - + - + = σ σ ρ σ σ σ
5 - 5 Attainable Portfolios: ρ AB = 0.4 ρ AB = +0.4: Attainable Set of Risk/Return Combinations 0% 5% 10% 15% 20% 0% 10% 20% 30% 40% Risk, σ p Expected return
5 - 6 Attainable Portfolios: ρ AB = +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
5 - 7 Attainable Portfolios: ρ AB = -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
5 - 8 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
5 - 9 Expected Portfolio Return, r p Risk, σ p Efficient Set Feasible Set Feasible and Efficient Portfolios
5 - 10 The feasible set of portfolios represents all portfolios that can be constructed from a given set of stocks. An efficient portfolio is one that offers: the most return for a given amount of risk, or the least risk for a give amount of return. The collection of efficient portfolios is called the efficient set or efficient frontier .
5 - 11 I B 2 I B 1 I A 2 I A 1 Optimal Portfolio Investor A Optimal Portfolio Investor B Risk σ p Expected Return, r p Optimal Portfolios
5 - 12 Indifference curves reflect an investor’s attitude toward risk as reflected in his or her risk/return tradeoff function. They differ among investors because of differences in risk aversion.

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• Fall '13