Reading #44 - Risk and Return Part 2 Flashcards
define the capital market line (CML)
“the optimal CAL for all investors”
CML EQUATION E(Rp) =
Rf+ [(E(rm)-Rf)/(stnd market)]stnd dev portfolio
what is the y-intercept of the CML, i.e. the slope Formula
(E(rm) - Rf)/stnd market
define the market risk premium
“the expected return on the market and the RFR “
define passive investment strategy
strategy that believes “market prices are informationally efficient”
define unsystematic risk
“risk that is eliminated by diversification”
define systematic risk
“risk that remains cannot be diversified away”
is equilibrium security returns depend on total risk of portfolio’s systematic risk?
systematic risk because investors “will knot be compensated for bearing risk that can be eliminated at no cost”
define return generating models
“used to estimate the expected returns on risky securities based on specific factors”
define multifactor models
“use macroeconomic factors to estimate the expected returns on risky securities”
define Fama and French Model
“estimated sensitivity of security returns to three factors: firm size, firm book value to market value and return on market portfolio - RFR”
define Carhart model
“fama and french plus factor that measures price momentum using prior period returns”
define beta
“sensitivity of asset’s return to return on market index in context of the market model”
calculate beta of an asset
“cov(investment,mkt)/ stnd dev squared (of mkt)”
what is the security characteristic line?
the regression line against the market asset returns - the slope is the same formula to find beta (cog of investment/ stand dev of mkt squared)
what is the security market line (SML)
the line that result from relationship between E(r) risk and return for individual assets using covariance
define CAPM
“relation between beta (systematic risk) and expected return”
assumptions of CAPM:
- risk aversion 2. utility maximizing investors 3. frictionless markets 4. one period horizon 5. homogeneous expectations 6. divisible assets 7. competitive markets
what is the sharpe ratio
measure of “excess returns per until of total portfolio risk”
FORMULA sharpe ratio
r(p) - rf/stnd dev of portfolio
define m -squared
“produces the same port. rankings as Sharepe ratio but is stated in % terms”
formula for m-squared
(rp - rf)(stnd dev mark/stnd dev port)-(rm -rf)
what are the two measures that are based on systematic risk?
Treynor measure and Jenson’s alpha
what are the two measure that are NOT based on systematic risk?
M squared and sharpe ratio
what is Treynor measure based on? slope or % return
based on the slope
what is Jenson’s alpha based on? slope or % return?
% return - like standard deviation but it lies on SML
what is formula for Treynor measure?
(rp - rf)/ beta of portfolio
Jenson’s alpha formula
Rport - [Rf +beta port(rm-rf)]
when is it appropriate to use Treynor and Jenson’s alpha?
“when fund uses multiple managers so that the overall fund portfolio is well diversified, i.e. no systematic risk”
what is the slope of the SML?
“The slope of the line is given by the market risk premium, the difference between the equity market return and the risk-free rate of interest”
what does SML represent?
the CAPM with beta on x axis and return on y axis
