AFM273 Chapter : AFM 273 Textbook Notes & Economic Indicators (Some)

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Figure 13. 1 (p. 445) -> if market portfolio =/= efficient portfolio, market not in capm equilibrium. Possibility news is announced that some stocks" expected return & some stocks" expected returns. With new information, market portfolio no longer efficient. Alternative portfolios offer a expected return & volatility than we can obtain by holding the market portfolio. Investors alter their investments in order to make their portfolios efficient. To improve performance of portfolios, investors who are holding the market portfolio will compare the expected return of each security s w/ its required return from capm: rs = rf + s (e[rmkt] - rf) Figure 13. 2 (p. 445) -> market portfolio not efficient, stocks will not lie on sml. Improve upon market portfolio by buying stocks with + & selling stocks with - . Result: prices chg & shrink towards 0 (move toward sml) Alpha: difference b/w stock"s expected return & its required return according to sml.

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