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6 0 75 what if an asset has a reward to risk ratio of

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Unformatted text preview: rd-to-risk ratio of 7 What (implying that the asset plots below the line)? (implying 33 33 Market Equilibrium In equilibrium, all assets and portfolios must In have the same reward-to-risk ratio and they all must equal the reward-to-risk ratio for the market must E ( RA ) − R f βA = E ( RM − R f ) βM 34 34 Security Market Line The security market line (SML) is the The representation of market equilibrium representation The slope of the SML is the reward-to-risk ratio: The (E(RM) – Rf) / βM (E(R But since the beta for the market is ALWAYS But equal to one, the slope can be rewritten equal Slope = E(RM) – Rf = market risk premium 35 35 The Capital Asset Pricing Model The (CAPM) (CAPM) The capital asset pricing model defines the The relationship between risk and return relationship E(RA) = Rf + βA(E(RM) – Rf) If we know an asset’s systematic risk, we can If use the CAPM to determine its expected return use This is true whether we are talking about This financial assets or physical assets financial 36 36 Factors Affecting Expected Factors Return Return Pure time value of money – measured by Pure the risk-free rate the Reward for bearing systematic risk – Reward measured by the market risk premium measured Amount of systematic risk – measured by Amount beta beta 37 37 Figure 13.4 38 38...
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