Unformatted text preview: rdtorisk 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 rewardtorisk ratio and they all
must equal the rewardtorisk 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 rewardtorisk 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 riskfree 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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 Spring '14
 Capital Asset Pricing Model, Financial Markets, Modern portfolio theory

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