Lecture 6

Question 1

Capital Market Line

Answer 1

• Horizontal axis measured by SD (Total risk)
• Investors prefer more return to less return at any given level or risk
• They will choose the steepest line possible (CML)
• It allows investors to separate their risk aversion from their choice of which assets to hold

Question 2

CAPM (assumptions)

Answer 2

• The only characteristics of return that nvestors are interested in are mean and variance
• Homogenous expectations
• Investros have identical expectations
• Markets are frictionless

Question 3

SML

Answer 3

• Horizontal axis si measured by beta as we assume the market is well diversified
  Market risk premium = return of market portfolio - risk free beta
  Beta if the market portfolio - 1
  Beta of the risk free asset = 0
  Beta of a portfolio = weighted average beta of all assets