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Advanced Finance > Lecture 6 > Flashcards

Lecture 6 Flashcards

1
Q

Assumptions of CAPM (6)

A
  • Many investors, each with small wealth in comparison to overall wealth
  • All investors plan for identical holding period
  • Investments limited to publicly traded financial assets
  • Investors pay no taxes
  • Investors are rational, mean variance optimisers
  • All investors analyse securities in the same way
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2
Q

CAPM theory

A

All investors chose to hold a portfolio of risky assets in the proportions that duplicate the representation of assets in the market portfolio

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3
Q

Market portfolio under CAPM

A

On the efficient frontier and tangency portfolio to optimal CAL

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4
Q

The risk premium on the market portfolio is

A

Proportional to its risk and the degree of risk aversion of the representative investor

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5
Q

The risk premium on an individual’s assets is

A

Proportional to the risk premium of the market portfolio (M) and the beta coefficient of the security relative to the market portfolio

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6
Q

When aggregated, portfolios of all individual investors lending and borrowing

A

Cancel out

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7
Q

Value of the aggregate risky portfolio =

A

Entire wealth of the economy

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8
Q

Proportion of each stock in the portfolio formula =

A

Market value of the stock / Sum market value all stocks

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9
Q

CAPM implies that

A

As individuals attempt to optimise person portfolios, they arrive at the same portfolio with equal weightings. Therefore if investors use identical Markowitz analysis applied to same securities in same time horizons, will arrive at same composition

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10
Q

Optimal risky portfolio of all investors =

A

Share of market portfolio

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11
Q

Price adjustment process ensures

A

All stocks are included in the market portfolio, only issue is price at which investors willing to include stock in their portfolio

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12
Q

CML =

A

Graphs the risk premiums of efficient portfolios as a function of the portfolio standard deviation

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13
Q

M =

A

Optimal tangency portfolio on the efficient frontier

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14
Q

Assuming all investors chose to hold market index mutual fund, portfolio selection depends on (2)

A
  • Technical problem > creation of mutual funds by professional managers
  • Personal problem > investor’s risk aversion
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15
Q

CAPM built the insight that

A

The appropriate risk premium of an asset is determined by its’ contribution to the risk of the investor’s overall portfolios

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16
Q

Stock’s contribution to the risk of a market portfolio depends on

A

The covariance of that portfolio

17
Q

Basic principle equilibrium =

A

All investors should offer the same risk to reward (balances out if they offer different)

18
Q

Beta measures

A

The contribution of the stock to the variance of the market portfolio

19
Q

Beta = 1

A

Weighted average value of beta across all assets (market’s beta)

20
Q

Beta > 1 =

A

Aggressive > above average sensitivity

21
Q

Beta < 1 =

A

Defensive > below average sensitivity

22
Q

Security market line graphically portrays

A

The expected return-beta relationship (for individual assets)

23
Q

Slope of SML =

A

Risk premium of the market portfolio

24
Q

SML provides a benchmark

A

For the evaluation of investment performance (then can use sensitivity analysis)

25
Q

Fairly priced assets

A

Plot onto the SML

26
Q

In the market equilibrium

A

All securities lie on the SML

27
Q

If the stock’s expected return is greater than the fair return stipulated by the SML

A

Stock is underpriced, will plot above SML line

28
Q

If the stock’s expected return is less than the fair return stipulated by the SML

A

Stock is overpriced, will plot below the SML line

29
Q

Difference between the fair and actual expected return on a stock =

A

Alpha

30
Q

Positive alpha =

A

Underpriced

31
Q

Negative alpha =

A

Overpriced

Advanced Finance (20 decks)

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