# Capital Market Theory (Chap 9,10 of RWJ) - PowerPoint PPT Presentation

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Capital Market Theory (Chap 9,10 of RWJ). 2003,10,16. Returns. Dollar returns: terminal market value – initial market value Percentage returns=dollars returns/initial market value Dividend yield=dividend at end of period / present price Capital gain= price change of stock / initial price

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Capital Market Theory (Chap 9,10 of RWJ)

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## Capital Market Theory(Chap 9,10 of RWJ)

2003,10,16

### Returns

• Dollar returns: terminal market value – initial market value

• Percentage returns=dollars returns/initial market value

• Dividend yield=dividend at end of period / present price

• Capital gain= price change of stock / initial price

• Total returns= dividend yield + capital gains

### Holding period returns

• (1+R1)(1+R2)…(1+RT) for T years

• Small-company

• Large-company

• Long-term government bonds

• Treasury bill

• inflation

### Average stock return and risk-free return

• Risk-free return:

• Risk premium = excess return on the risky asset = risky asset return – risk-free return

• Risky returns as a normal distribution

• Expected return

• Variance

• Covariance

• Correlation

• Expected return of a portfolio is the weighted sum of individual expected return.

### Diversification effect

• As long as correlation <1, the standard deviation of a portfolio of two securities is less than the weighted average of the standard deviations of the individual securities.

• Extend to more securities.

### Efficient set (efficient frontier) for two assets

• Minimize variance of portfolio for constant expected mean.

### Limit of reduced variance

• Portfolio who contains all assets.

• Variance as “ risk”.

• Total risk of individual security = portfolio risk (systematic risk) + diversifiable risk (or unsystematic risk)

### Market equilibrium

• In a world of homogeneous expectations, all investors would hold the portfolio of risky assets

• Market portfolio: market-value-weighted portfolio of all existing portfolio.

### Beta

• Beta measures the responsiveness of a security to movements in the market portfolio

• Beta_i=Cov(R_i,R_M)/Sigma^2(R_M)