332 Conceptual Stuff

Two Fund Seperation

The two Tasks: Determine the Tangency Portfolio which is not a personal Choice; It is the the highest Sharp Ratio.

Then mix the Tangency Portfolio and the riskless asset. This is Personal and Depends on the Utility Function

What does CAPM do

How u can measure risk, and how can you quantify the relation between return and risk.

What is CAPM

Everyone holds a combination of the market portfolio and the riskless asset. The risk is the covariance of the asset with the market portfolio.

What is the idea

Everyone holds the market portfolio and the riskless asset.

What is the tangency portfolio

This is the market Portfolio

What is the difference between SML and CAL

CAL tells u the risk between a risk free asset and the risky asset. S.D> is on the X axis.

SML tells u if the asset is correctly priced or not. Beta is on the X axis

Why does the CAPM model say high beta stocks are risky.

Because very bad returns if your portfolio suffers. High variance doesnt mean high returns

Idiosyncratic Risk

Risk you can diversify away

Systematic Risk

Beta tells you how much of the market's risk gets passed through to your stock — squaring just converts it into variance form

What is a

The abonormal Risk-Adjusted Return

3 Forms of EMH

Weak form - just past info

Semi- Strong Form all public info

Strong Form- everything

Why are markets efficient

Force of Arbitrage

If markets are perfectly efficiant everyone must follow a passive portfolio strategy.

Joint Hypothesis Problem

The two possiblities of high average return—> market is inefficient or model for measuring risk is wrong

Extending on CAPM

Security is attractive if it pays up when times are bad.

CRR (Chen, Roll, and Ross)

Arbitrage Pricing theory . Must incorporate expected inflation, unexpected inflation

What is a multifactor model

Calculating Beta’s for other things

FF ( Fama and French)

Have a second factor of size ( Small Caos have higher Betas)

Third Factor of book to market ( High book to market ratios have high) HML betas.

Capital Gain Tax

Sell at a loss before tax season then buy back at same priceto get an expense

Why small cap

Big capital losses tend to be from small cap stocks

Value Versus Growth

Low P/E or low market equity to book equity

Value stocks outperform Growth Stocks and do not have higher vairences, betas, or underperform

Investors over react to good news associated with growth stocks, and over pessimistic about value stocks

Investor Underreaction

On average stocks that perform well in the past few months conitinue to perform nbetter, the momentum effect.

Forming a portfolio of winners in the past dsix months, and losers porfolio for the next 6 the winners always do better.