SESSION 2‚ 2012 Lecture 5: The Capital Asset Pricing Model Last Week 2 Index models Systematic and idiosyncratic risks Calculating covariance Case study Calculating systematic and idiosyncratic risks Investment strategies Required return Reward-to-risk ratio Today 3 Asset pricing models: what and why The Capital Asset Pricing Model (CAPM) Assumptions The claim Implications The economic mechanism The reality check Applications Extensions
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FINS2624 PORTFOLIO MANAGEMENT Week 6 CAPM: The covariance of an assets returns with the market and the required return of the asset. Assumptions: * Investors are price takers * Investors have identical investment horizons * Perfect capital markets * Investors are rational mean-variance optimizers β: Measures how much risk an asset contributes in the market portfolio. * β > 1 asset contributes more risk than the average asset * β < 1 asset contributes less risk
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share X and 40% in share Y‚ what is the standard deviation of the portfolio? a. 10% b. 20% c. 12.2% d. 14.0% e. None of the above 4. Richard Rolls critique of tests of the capital asset pricing model is that: a. Given an efficient market portfolio the CAPM is tautology b. The market portfolio is not efficient c. You need to test the model using the market portfolio for all capital assets d. a and c e. a and b 5. The Template Corporation has an equity beta of 1.2 and a debt beta of .8. The firm’s market
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has argued that to claim whether the CAPM is dead or alive‚ some improvements on the model must be considered. Rather than take the view that one theory is right and the other is wrong‚ it is probably more accurate to say that each applies in somewhat different circumstances (assumptions). Finally it’s argued that even the examination of the CAPM’s variants is unable to solve the debate into the model. Rather than asserting the death or the survival of the CAPM‚ we conclude that there is no consensus
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and a negative weight in the market G) i‚ more idiosyncratic risk than market portfolio Question 6 A) The return data of the four funds is given below. It is clear that DFA has the best risk adjusted returns as captured by the Sharpe ratio. It has the disproportionately high returns for the risk taken. So‚ in order of performance‚ the funds are enlisted below: 1) DFA 2) Diversified 3) T. Rowe Price 4) Goldman B) Using CAPM I gave regressed excess stock return with excess
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SEAT NUMBER: ……….… ROOM: .………………. FAMILY NAME.………….....…………………………. This question paper must be returned. Candidates are not permitted to remove any part of it from the examination room. OTHER NAMES…………….…………………..…….. STUDENT NUMBER………….………..…………….. SESSION 1 EXAMINATIONS JUNE 2012 Unit: AFIN253: Financial Management Time Allowed: 2 hours plus 10 minutes reading time. Total Number of Questions: 20 Multiple Choice Questions plus 6 full response questions. Instructions: 1. PART A (60 marks):
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assist investors to predict future performance and value” Performance = N.I. Value = share price vi. Via a “more informative information system” • QUALIFIERS i. ii. (185) “Beta is the only relevant risk measure according to the CAPM” “there is evidence that accounting variables … do a better job than beta in predicting share return” • RISK vs. RETURN i. “Perhaps accountants should take more responsibility for reporting on firm risk” 1 JUSTIFICATION FOR THE
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Question 1 (5 points) By simply increasing the number of assets (e.g.‚ assets > 30) in any portfolio‚ you can diversify your exposure to specific/idiosyncratic risk. False. True. Question 2 (10) You have an equally weighted portfolio that consists of equity ownership in three firms. Firm A is trading at $23 per share and has a beta of 1.15; Firm B is trading at $16 per share with a beta of 1.60; Firm C is trading at $76 per share with a beta of 0.85. Assume a risk free rate of 2% and market
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1. On one half a page review what does our traditional finance framework and the CAPM model‚ for example‚ have to say about risk? What is it? How is it approached? The traditional finance framework uses discounted expected future cash flow to determine the NPV of the project. The amount of the opportunity cost is based on a relation between the risk and return of some sort of investment. People are rational and adverse to risk and need incentive to accept risk. The incentive in finance comes in
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prices as compensation for assets ’ tendency to pay off poorly in "bad times." I survey the literature‚ covering the time-series and cross-sectional facts‚ the equity premium‚ consumption-based models‚ general equilibrium models‚ and labor income/idiosyncratic risk approaches. John H. Cochrane Graduate School of Business University of Chicago 5807 S. Woodlawn Chicago‚ IL 60637 and NBER john.cochrane@gsb.uchicago.edu 1 Introduction Risk premia Some assets offer higher average returns
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