Professional Documents
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Portfolio Management
by Frank K. Reilly & Keith C. Brown
An Introduction to
Asset Pricing Models
Chapter 8
8-5
8-7
E(RM ) RFR
E(Rport ) RFR port [
]
M
This relationship holds for every combination of the
risk-free asset with any collection of risky assets
However, when the risky portfolio, M, is the market
portfolio containing all risky assets held anywhere in
the marketplace, this linear relationship is called the
Capital Market Line (Exhibit 8.1)
8-8
Exhibit 8.1
8-9
Exhibit 8.2
8-11
8-14
Exhibit 8.3
8-16
8-17
Portfolio Return
E(Rport)=RFR+port[(E(RM)-RFR)/M)
=4%+15%[(9%-4%)/10%]=11.5%
8-19
Exhibit 8.5
8-23
Beta
0.70
1.00
1.15
1.40
-0.30
7.8%
9.0%
9.6%
10.6%
3.8%
8.0%
6.2%
15.15%
5.15%
6.0%
Exhibit 8.8
8-27
i
Cov ( Ri , RM )
i
riM
M
M2
The characteristic line
A regression line between the returns to the security (Rit)
over time and the returns (RMt) to the market portfolio
R i, t i i R M, t
Exhibit 8.10
8-29
8-30
Exhibit 8.12
8-33
Taxes
Differential tax rates could cause major differences
in the CML and SML among investors
8-34
8-35
Exhibit 8.18
8-38
Summary
The assumption of capital market theory
expand on those of the Markowitz portfolio
model and include consideration of the riskfree rate of return
The dominant investment opportunity is the
line tangent to the efficient frontier at the
market portfolio, known as the CML
Investors can move along the CML by
investing in both risk-free rate and the market
portfolio through either lending or borrowing
8-39
Summary
The relevant risk measure for an individual
risky asset is its systematic risk or covariance
with the market portfolio
SML is derived to show the relationship
between the required return and its systematic
risk for any risky asset
Assuming security markets are not always
completely efficient, you can identify
undervalued and overvalued securities by
comparing your estimate of the rate of return
on an investment to its required rate of return
8-40
Summary
When we relax several of the major
assumptions of the CAPM, the required
modifications are relatively minor and do not
change the overall concept of the model
Betas of individual stocks are not stable while
portfolio betas are stable
There is a controversy about the relationship
between beta and rate of return on stocks
Changing the proxy for the market portfolio
results in significant differences in betas,
SMLs, and expected returns
8-41
8-42
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