capital asset pricing model Flashcards
what is the two fund seperation theoreom?
The two-fund separation theorem states that
investors will invest only in the risk-free asset and
a portfolio of risky assets determined by the
Capital Market Line.
if all prices are in equillibrium, the portfolio of risky assets will represent the entire market
the assumptions of the capital asset pricing model?
- Investors make decisions based only on the expected
value and standard deviation of the returns of their
portfolio. - Investors have homogeneous expectations about the
payoff of all stocks. - No transaction costs.
- No taxes.
- Unlimited borrowing and lending at the risk-free rate
is allowed. - All investors are price takers.
what does the investors homogenous expectations mean about the investors opportunity sets?
they all have the same opportunity sets
what does the market portfolio reflect?
the market portfolion reflects the markets equillibrium prices. the prices of all assets must adjust until all are held and there is no excess demand
the market portfolio is an efficient portfolio because investors hold it in equillibrium
what does the proportion of each asset in the market portfolio reflect?
the proportion of each asset in the market portfolio reflects the market values of the assets
what are the properties of the security market line and the capital asset pricing model?
the risk adjusted return on every asset must be on the SML in equillibrium
the risk free asset has β=0; the market portfolio has β=1
where β of a portfolio is weighted average of β’s of the constituent
assets
what is the formula for the required rate of return?
the required rate of return = the risk free rate + the risk premium (specific to each asset i)
what is the formula for the risk premium?
the risk premium is equal to the price of risk multiplied by the quantity of the risk
