Introduction Flashcards
1
Q
CAPM assumptions
A
- Individual investors are price takers
- Single period investment horizon
- Investments are limited to traded financial assets
- No taxes and transaction costs
- Information is costless and available to all
- Investors are rational mean variance optimizers
- There are homogeneous expectations
2
Q
Security market line (SML)
A
Individual assets risk premium as a function of asset risk, goes through rf and rm.
All investments must stay on SML. Outside can’t exist because alfa is zero in CAPM.
3
Q
Principle of equilibrium
A
All investments offer the same reward-to-risk ratio
formula
4
Q
Beta effect
A
beta = 1, perfect correlation with market
beta < 1, defensive asset, less risk
beta > 1, aggressive asset, riskier
5
Q
Three factor model
A
beta, market value (SMB), book-to-market (HML)
6
Q
Four factor model
A
beta, market value (SMB), book-to-market (HML), momentum (WML) (stock that performed well in past six months, will perform well in next six months)
7
Q
Asset’s beta
A
Contribution of the asset to the portfolio variance
