Flashcards in Chapter 9 CAPM Deck (23)

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1

## CAPM

### helps to answer the question what premium should this investment be so that it can be a competitive investment compared to other investments (cost of equity)

2

## risk-averse investors require what in order to invest

### a risk premium (higher percentage, rate) to be given an incentive to accept risk

3

## what are insurance premiums

### investors pay this insurance premium to get out of risky situations, therefore we conclude that investors will only choose portfolios tha tare members of the efficient frontier

4

## risk-free asset's return how does their sd and correlation look

###
they do not vary,

the standard deviation is zero

- correlation between risk free and a portfolio a is also zero

5

## SD increase in direct what

### proportion to the amount invested in the risky asset

6

## portfolios of risky securities that lie along the efficient frontier - that is on the curve above te minimum variance portfolio are (MVP) are

###
efficient and dominate all other possible portfolios of risky securities

- these portfolios offer the highest expected rate of return

7

## what is risk premium

### the expected payoff that induces a risk-averse person to enter into a risky situation

8

## Investors will only choose what portfolios

### on the efficiency frontier that are above MVP

9

## portfolios on flatter lines are what

### are chosen by less risk-averse investors

10

## portfolios higher or steeper than others

### investors will require a higher return

11

## how do investors differ

### in their risk aversion

12

## what is the formula to estimate the expected return on a portfolio

###
ERp = RF + W(ERa - RF)

or

ERpexpected return on portfolio that starts out with w = 0

RF - risk free rate

ERa -

13

## the higher the portfolio allocation (weight) directed to the risky asset

### the higher the portfolio risk

14

## if w=0

### this is the risk free rate or T-bill amount

15

## Tangent portfolio - definition

### the risky portfolio on the efficient frontier whose tangent line cuts the vertical axis at the risk-free rate

16

## new (or super) efficient frontier

### portfolios composed of the risk-free rate and the tangent portfolio that offer the highest expected rate of return for any given level of risk

17

## what is negative or short position

### a negative position in an asset; the investor achieves a short position by borrowing part of the asset's purchase price form the stockbroker

18

## what is margin

###
means the investor borrows part of the purchase price from the stockbroker

ex.

some stocks have margin requirements as low as 30%, indicating an investor could buy $1,000 worth of stocks by investing only $300 and borrowing the reaming $700 form the broker

- in this case, the portfolio weights are w = 1,000 / 300 or 333% in the risky asset and -233% in the risk-free asset

19

## what is the bad part about margin

###
the investor pays interest on the borrowed amount

- investor is called a short seller

20

## what sort of other risks do short sellers are subject to

###
1. experiencing unlimited losses

2. risking being asked to "cover" their short position ( by purchasing the amount of shares sold)

3. having to cover dividends paid on the underlying stock while they are in the short position

21

## separation theorem

### the theory that the investment decision (how to construct the portfolio of risky assets) is separate form the financing decision (how much should be invested or borrowed at the risk-free rate)

22

## what is market portfolio

###
a portfolio that contains all risky securities in the market

- theoretically should contain all risky assets worldwide, including stocks, bonds, options, futures, gold, real estate etc. in their proper proportions

- such a portfolio would be completely diversified

- not real

- use market indexes, such as the S & P / TSX and S&P 500 used to measure its behaviour

23