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Diagrams of CAPM

Diagrams of CAPM. Chapter 10 figures. Investors need only two funds. Figures 10.4, 10.5, and 10.6. Correlation coefficient. Portfolio variance. In terms of the correlation coefficient. MV. MV. MV. Diversification, minimum variance. B. E(R). A. s. The case of r = 1.

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Diagrams of CAPM

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  1. Diagrams of CAPM Chapter 10 figures

  2. Investors need only two funds. • Figures 10.4, 10.5, and 10.6.

  3. Correlation coefficient

  4. Portfolio variance In terms of the correlation coefficient

  5. MV MV MV Diversification, minimum variance B E(R) A s

  6. The case of r = 1

  7. Portfolio expected return

  8. Still r = 1

  9. Expected return

  10. Substitute out XB

  11. MV MV MV Diversification, minimum variance B E(R) A s

  12. Nowr= -1

  13. MV Diversification with a risk-free asset B E(R) A= risk-free asset s

  14. . Y . X Capital Market Line Expected returnof portfolio Indifference curve Capital market line . preferred . M . . Risk-freerate (Rf ) Standarddeviation ofportfolio’s return.

  15. Argument for the security market line • Only beta matters • A mix of T-Bills and the market can produce any beta. • An asset with that beta is no better or worse than the two-fund counterpart • Hence it has the same return.

  16. . T . S 0.8 Security Market Line T is undervalued. Its price rises Expected returnon security (%) Security market line (SML) . . . . Rm M Rf S is overvalued. Its price falls Beta ofsecurity 1

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