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Chapter 9
Charles P. Jones, Investments: Principles and Concepts,
Twelfth Edition, John Wiley & Sons
91
92
Assumes all
investors:
Use the same
information to
generate an efficient
frontier
Have the same oneperiod time horizon
Can borrow or lend
money at the risk-free
rate of return
No transaction costs,
no personal income
taxes, no inflation
No single investor
can affect the price
of a stock
Capital markets are
in equilibrium
93
94
E(R)
Z implies lending
T
Z
RF
A
Set of portfolios on
line RF to T
dominates all
portfolios below it
Risk
9-5
96
L
M
E(RM)
x
RF
M
Risk
Line from RF to L is
capital market line
(CML)
x = risk premium
=E(RM) - RF
y =risk =M
Slope =x/y
=[E(RM) - RF]/M
y-intercept = RF
9-7
E(RM ) RF
E(Rp ) RF
p
M
98
99
910
911
912
Beta
Standardized measure of systematic risk
Relative measure of risk: risk of an
individual stock relative to the market
portfolio of all stocks
Relates covariance of an asset with the
market portfolio to the variance of the
Covi, M
market portfolio
913
Beta
SM
L
E(R)
kM
kRF
Security C is less
risky than the
0.5 1.0 1.5 2.0 market
BetaM
Beta <1.0
9-14
ki = RF +i [ E(RM) - RF ]
915
916
Market model
Relates the return on each stock to the return on
the market, assuming a linear relationship
Produces an estimate of return for any stock
Ri = i + i RM +ei
Characteristic line
Line fit to total returns for a security relative to
total returns for the market index
917
918
919
Tests of CAPM
Assumptions are mostly unrealistic
Empirical evidence has not led to consensus
However, some points are widely agreed
upon
920
921
922
923
924
925