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    Capital Market Theory: Amit Singla

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    This document discusses capital market theory, including the Markowitz model and efficiency frontier, the evolution of the Capital Asset Pricing Model (CAPM), assumptions of CAPM, the capital market line, security market line, and their applications. The CAPM explains the relationship between expected return and risk of securities. It assumes investors have homogeneous expectations and can freely borrow/lend at the risk-free rate. The capital market line depicts the relationship between expected return and total risk of efficient portfolios, while the security market line shows this for individual securities.

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    Capital Market Theory: Amit Singla

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    amitsingla19
    399 views9 pages
    This document discusses capital market theory, including the Markowitz model and efficiency frontier, the evolution of the Capital Asset Pricing Model (CAPM), assumptions of CAPM, the capital market line, security market line, and their applications. The CAPM explains the relationship between expected return and risk of securities. It assumes investors have homogeneous expectations and can freely borrow/lend at the risk-free rate. The capital market line depicts the relationship between expected return and total risk of efficient portfolios, while the security market line shows this for individual securities.

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    Capital Market Theory

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    This document discusses capital market theory, including the Markowitz model and efficiency frontier, the evolution of the Capital Asset Pricing Model (CAPM), assumptions of CAPM, the capital market line, security market line, and their applications. The CAPM explains the relationship between expected return and risk of securities. It assumes investors have homogeneous expectations and can freely borrow/lend at the risk-free rate. The capital market line depicts the relationship between expected return and total risk of efficient portfolios, while the security market line shows this for individual securities.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
    399 views9 pages

    Capital Market Theory: Amit Singla

    Uploaded by

    amitsingla19
    This document discusses capital market theory, including the Markowitz model and efficiency frontier, the evolution of the Capital Asset Pricing Model (CAPM), assumptions of CAPM, the capital market line, security market line, and their applications. The CAPM explains the relationship between expected return and risk of securities. It assumes investors have homogeneous expectations and can freely borrow/lend at the risk-free rate. The capital market line depicts the relationship between expected return and total risk of efficient portfolios, while the security market line shows this for individual securities.

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    © All Rights Reserved
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    of 9

    Capital Market theory

    Markowitz Model and Efficiency Frontier


    Evolution of capital Asset Pricing Model
    Dominant Portfolio
    Separation Theorem
    Capital Market Line
    CAPM
    Security Market Line
    Application of CML and CAPM
    Amit Singla

    Markowitz Model and Efficiency


    Frontier
    Markowitz model of portfolio analysis
    generates an efficient frontier, which is a
    set of efficient portfolios.
    A portfolio is said to be efficient if it offers
    the maximum expected return for a given
    level of risk of it offers the minimum risk
    for a given level of expected return.
    Efficient frontier is a set of efficient
    portfolio.
    Amit Singla

    Evolution of capital Asset Pricing


    Model
    CAPM was developed in mid-1960 by William
    Sharpe John Linter and Jan Mossin.
    It explains the relationship that should exist
    between the securities expected return and their
    risk in terms of the means and standard deviation
    about security returns.
    CAPM is a direct extension of Markowitz model.

    Amit Singla

    Assumption of CAPM
    All investors are considered to be efficient
    investors who like to position themselves on the
    efficient frontier.
    Investors are free to borrow or lend any amount
    of money at risk free rate of return.
    All investors are expected to have homogeneous
    expectations.
    All investors have same investment time
    horizons.
    No transaction costs.
    Inflation rate is fully anticipated.
    All investments are correctly priced.
    Amit Singla

    Standard deviation Vs. Beta


    Risk Free asset
    Covariance of a risk-free asset with a risky asset
    Combining a risk free asset with a risky portfolio
    Risk return possibilities with leverage
    Lending and borrowing at the riskless rate:
    Combining any risky portfolio with a riskless asset produces a
    linear relationship between their respective E(r), points
    Combination of a risky portfolio with riskless asset are
    generally reffered to as lending portfolios, since some of the
    investment is invested or lent at the riskless rate.
    When the percentage of portfolio invested in riskless security f
    is negative, the resulting portfolio is reffered to as borrowing
    portfolio.
    As long as the E(rm)>rf investor could continue to borrow to
    increase its expected return and risk and vice versa i.e.
    lending.
    Amit Singla

    Dominant Portfolio
    The portfolios on the line rfM always
    dominate the portfolios on the efficient
    frontier.
    Because of this dominance, all investors
    should choose efficient portfolio M.
    M is the efficient portfolio that maximizes
    the value of risk premium.
    Amit Singla

    Separation Theorem
    The separation of investing (to lend) and
    financing decisions (to borrow) is called
    the separation theorem.

    Amit Singla

    Capital and security market line


    The capital market line: A line used in the capital

    asset pricing model to illustrate the rates of return for efficient


    portfolios depending on the risk-free rate of return and the level of
    risk (standard deviation) for a particular portfolio.

    CAPM: A model that describes the relationship between risk


    and expected return and that is used in the pricing of risky
    securities.

    Security market line: The line that graphs the

    systematic or market risk versus return of the whole market at a


    certain time and shows all risky marketable securities. (individual
    Security)

    Reconciling CML with SML


    Amit Singla

    Application of CML and CAPM


    CML depicts the linear relationship between expected
    return and total risk of all efficient portfolios; while SML
    depicts the linear relationship between expected return
    and systematic risk of all individual securities and all
    portfolios.
    Understanding of CAPM also covers the application of
    the CML.
    SML can be used for:
    Evaluating the performance of portfolio
    Test of asset pricing theories
    Test of market efficiency
    Identified mispriced securities
    Amit Singla

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