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##### Diagrams of CAPM

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**Diagrams of CAPM**Chapter 10 figures**Investors need only two funds.**• Figures 10.4, 10.5, and 10.6.**Portfolio variance**In terms of the correlation coefficient**MV**MV MV Diversification, minimum variance B E(R) A s**MV**MV MV Diversification, minimum variance B E(R) A s**MV**Diversification with a risk-free asset B E(R) A= risk-free asset s**.**Y . X Capital Market Line Expected returnof portfolio Indifference curve Capital market line . preferred . M . . Risk-freerate (Rf ) Standarddeviation ofportfolio’s return.**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.**.**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