Lecture 2: Asset Pricing 1 (Portfolio Theory & CAPM)

Question 1

Markowitz PORTFOLIO THEORY:
(Check out Eggshell diagram!)
- Market portfolio:
> [.] of the Capital Market Line (CML) and Efficient Frontier
> maximise [.] & max [.] for amount of risk taken.
- Any portfolio that fits on the CML is BETTER than any possible portfolios to the [.] of that line.

Answer 1

Markowitz PORTFOLIO THEORY:
(Check out Eggshell diagram!)
- Market portfolio:
> intercept of the Capital Market Line (CML) and Efficient Frontier
> maximise diversification & max returns for amount of risk taken.
- Any portfolio that fits on the CML is BETTER than any possible portfolios to the RIGHT of that line.

Question 2

CAPM:
Risk-Return line (or SML)’s equation:
E(r_i) = […]
Beta_i = [./.] : undiversifiable risk
Systematic risk (Beta) is the only factor that explains expected [.] of any assets
–> CAPM: investors are only rewarded for taking on extra [.] risks.

Answer 2

CAPM:
Risk-Return line (or SML)’s equation:
E(r_i) = r_f + Beta_i * (r_m - r_f)
Beta_i = cov(r_i, r_m) / variance_market: undiversifiable risk
Systematic risk (Beta) is the only factor that explains expected returns of any assets
–> Investors are only rewarded for taking on extra systematic risks.

Question 3

CAPM:

[.] & [.] can be a proxy for market portfolio.

Answer 3

CAPM:

S&P500 and FTSE 100 can be a proxy for market portfolio.

Question 4

CAPM: 1st attempt to model equilibrium [..] on asset classes.

Answer 4

CAPM: 1st attempt to model equilibrium expected returns on asset classes.

Question 5

CAPM is a [.., ..] model that has various issues e.g.:

• identify [.] portfolio
• discovery of other factors that explain asset returns over & above Beta
• poor empirical performance

Answer 5

CAPM is a SINGLE FACTOR, SINGLE PERIOD model that has various issues e.g.:

• identify market portfolio
• discovery of other factors that explain asset returns over & above Beta
• poor empirical performance