FNCE10002 Lecture Notes - Lecture 9: Market Price, Systematic Risk, Capital Market

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tealcattle862

7 Oct 2018

School

University of Melbourne

Department

Finance

Course

FNCE10002

Professor

Howard

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Document Summary

In equilibrium, x must be the market portfolio (now denoted as m) Intercept of cml = (risk free rate: slope of cml = [(cid:3006)(cid:4666)(cid:4667) , the expected return on the market portfolio (in excess of the risk free rate) per unit of the (cid:373)a(cid:396)ket po(cid:396)tfolio"s total (cid:396)isk. What is asset pricing: a(cid:374) (cid:862)asset(cid:863) is so(cid:373)ethi(cid:374)g that e(cid:454)pe(cid:272)ted to ge(cid:374)e(cid:396)ate (cid:396)etu(cid:396)(cid:374)s i(cid:374) the futu(cid:396)e therefore, it has a value (or price) today. If we know the expected return, we can work out the price. Investors are risk averse individuals who maximize the expected utility of their end- of-period wealth. Investors make portfolio decisions on the basis only of expected return and return variance. The capm"s institution: all investors hold efficient portfolios comprising the market portfolio, m and the risk free security. Capm and beta: ()=+[(cid:4666)(cid:4667) ](cid:2010, the (cid:373)a(cid:396)ket (cid:862)p(cid:396)i(cid:272)e(cid:863) of (cid:396)isk is (cid:373)easu(cid:396)ed as (cid:4666)(cid:4667) , the systematic risk is measured by the beta , (cid:2010)

Related Questions

1. Suppose you are restricted to investing in a portfolio of only 2 risky securities. The expected return on security A is 5% and the expected return on security B is 7%. The market portfolio, which is a combination of security A and B, has an expected return of 6%.

a.) Show how to construct an optimal portfolio with an expected return of 9%, assuming there is no risk-free asset.

b.) Show how to construct an optimal portfolio with an expected return of 7%, assuming there is a risk-free asset returning 2%.

c.) Suppose you form a portfolio by making a $10 investment in the risk-free asset and a $60 investment in the market-portfolio. What would the risk-free rate have to be if your portfolio has an expected return of 4%?

tealarmadillo521

Suppose a large institutional investor Allianceâs portfolio hasa beta of 0.5. Another institutional investor Bestâs portfolio hasan expected return of 10 percent and a standard deviation of 15percent. Both portfolios have the same Sharpe ratio of 0.6, and themarket portfolio can be described as a portfolio comprising thesetwo with equal weights. Suppose there is a firm called Cunningcorporation, whose stockâs beta is 2 and it can borrow at the riskfree rate. Cunningâs equity value is Â£1 million and its debt isÂ£1.5 million. The present value of Cunningâs tax shield is Â£0.3million. Assuming that both CAPM and the Modigliani-Miller theoremwith corporate taxes hold, answer the following questions. a) Whatis the risk free rate? b) What is the expected return on the marketportfolio? c) What is the after-tax WACC of Cunning

harlequincrow531

Choose the correct answer:

The beta of an efficient portfolio: a. must be 1 since an efficient portfolio is perfectly positively correlated with the market portfolio.

b. is proportional to 1, depending on the proportion invested in the market portfolio.

c. is equivalent to the portfolio's standard deviation, since standard deviation is the measure of risk for an efficient portfolio.

d. is always less than 1.

Security A has a greater level of systematic risk than security B. The expected equilibrium return for A must be greater than that for B because:

a. B's price will fall as investors realize that B offers lower returns.

b. if it is not, then A's price will fall and B's price will rise as investors sell A and buy B.

c. the Security Market Line is negatively sloped.

d. the standard deviation of A's return is greater than B's.

In case of a simple CAPM being used to estimate a time series data:

a. the mean of a residual risk should be equal to zero.

b. the regression coefficient should be equal to zero.

c. the difference between the market return and the riskfree rate of return should be equal to zero.

d. the beta of the portfolio should be equal to zero.

In a CAPM framework, prohibiting short sales:

a. will prohibit investors from holding the market portfolio in equilibrium.

b. will make the security market line steeper.

c. will encourage investors to hold more riskless assets.

d. will not change the equilibrium.

FNCE10002 Lecture Notes - Lecture 9: Market Price, Systematic Risk, Capital Market

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