Asset Pricing Models

Question 1

Efficient Frontier

Answer 1

This is a hyperbola that shows all the possible combinations of the assets that
are being examined
The line of the hyperbola is known as the efficient frontier (also known as
Markowitz frontier

Question 2

Any spot inside left to the line has

Answer 2

A higher return for the same risk; or
oThe same return for less risk

Question 3

any point on the line is known as an

Answer 3

efficient
portfolio

Question 4

Indifference curve

Answer 4

This is a curve of all the points on a plane which are equally desirable to
the investor

Question 5

The optimum Point/portfolio

Answer 5

the point where the indifference curve of an investor is
at a tangent with the efficient frontier of all possible portfolio

Question 6

any point on an indifference curve lower would be inside the
efficient frontier and therefore

Answer 6

would have a superior portfolio out
there for the same risk

Question 7

any point on a higher indifference curve would be outside of
the efficient frontier and

Answer 7

therefore would not be possible

Question 8

The slope of the indifference curve will depend

Answer 8

on their risk orientation

Question 9

less risk adverse investors will require less
return for taking on extra risk, and hence they will have a

Answer 9

flatter
curve

Question 10

a more risk adverse investor will have a _____ sloped
curve as they will require a larger return for every extra bit of risk

Answer 10

steeper

Question 11

The less correlated this asset the better the resulting

Answer 11

efficient frontier

Question 12

he higher the slope of the line the better

Answer 12

As you are getting more return for less risk

Question 13

Tangency Portfolio: The optimal amount of risky asset and risk free asset is when the line is at a tangent to the

Answer 13

investment opportunity set

Question 14

an optimum portfolio is only made up of the______, This line is then called the Capital market Line (CML), Which will have the highest sharp ratio (return per point of SD)

Answer 14

market portfolio and risk free asset,

Question 15

The Capital Market Line: CML

Answer 15

Specifies the relationship between expected return and risk for efficient
portfolios

Question 16

CML formula

Answer 16

E(Rp) = Rf + [(E(Ro)-Rf)/σo]*σp,

Rf is the Y intercept; and
o Sharpe ratio is the gradient; and
o σpis x

Question 17

Sharpe Ratio

Answer 17

Shows how much return for each per cent of risk – rise over run

Question 18

Capital Allocation Line(CAL) is the line for the

Answer 18

individual investor

Question 19

Now the investors pick a point on the CML which best fits their preference

Answer 19

This point is where the indifference curve is tangent to the CML line

Question 20

1.?
2.?
P.?

Answer 20

1 shows a risk adverse investor
- 2 shows a risk oriented investor
- P is the tangent portfolio (T)

Question 21

Equilibrium with Homogenous Expectations

Answer 21

This is in an economy where all investors have the same view about risk and return

Question 22

Security Market Line (SML) known as beta

Answer 22

Looks at an individual stock as a component of the portfolio, therefore
only its systematic risk is important

Question 23

SML =

Answer 23

(Cov(Ri,Rm)/σm)