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

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Capital Market Theory (Chap 9,10 of RWJ)

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Capital market theory chap 9 10 of rwj

Capital Market Theory(Chap 9,10 of RWJ)

2003,10,16


Returns

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

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

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


Capital market theory chap 9 10 of rwj

  • Expected return

  • Variance

  • Covariance

  • Correlation

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


Diversification effect

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

Efficient set (efficient frontier) for two assets

  • Minimize variance of portfolio for constant expected mean.


Limit of reduced variance

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

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.


Capital market theory chap 9 10 of rwj

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)


Relation between risk and expected return capm

Relation between risk and expected return (CAPM)

  • R_M=R_F+ Risk premium

  • R=R_F+Beta(R_M-R_F)

  • Beta=0: riskless asset

  • Beta=1: Market portfolio


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