FINANCE IN A CANADIAN SETTING Sixth Canadian Edition. Lusztig, Cleary, Schwab. CHAPTER EIGHT CAPITAL MARKET THEORY. Learning Objectives. 1. Explain the role of risk-free assets in an efficient portfolio. 2. Define the capital market line (CML), and explain what its slope indicates.
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Lusztig, Cleary, Schwab
CAPITAL MARKET THEORY
1. Explain the role of risk-free assets in an efficient portfolio.
2. Define the capital market line (CML), and explain what its slope indicates.
3. Compare and contrast systematic and non-systematic risk, and discuss the role of each in establishing the security market line (SML).
4. Define beta measure, and explain why it is more stable for large portfolios than for small ones than for individual stocks.
5. Identify some of the weaknesses in the capital asset pricing model (CAPM), and discuss alternative theories.
The Attainable Set and the Efficient Set of Portfolios
The Markowitz Efficient Frontier and the Possibilities Resulting from Introducing a Risk-Free Asset
The Efficient Frontier when Lending and Borrowing Possibilities Are Allowed
The CML and the Components of Its Slope
– market portfolio = 1.0
betas are lower risk securities
1. An efficient portfolio has the highest expected return for a given level of risk or the lowest level of risk for a given level of expected return.
2. Capital market theory, based on the concept of efficient diversification, describes the pricing of capital assets in the market place. The new efficient frontier is called the capital market line (CML), and its slope indicates the equilibrium price of risk in the market.
3. Based on the separation of risk into its systematic and non-systematic components, the security market line (SML) can be constructed for individual securities (and portfolios).
4. Beta is a relative measure of risk, which indicates the volatility of a stock relative to a market index. While all betas change through time, betas for large portfolios are much more stable than those for individuals stocks