Week 3

Tangency portfolio: hughest sharpe ratio

Capital Market line C [CML]

A= measure of risk aversion

Risk aversion leads to a smaller weight but it will still be positive

Mutual fund theorem

All Investors are mean variance optimisers

A T-bill is a risk free assets

Large leverage bet - Makes an investment more risky

Capital Asset pricing Model (CAPM) - tangency portfolio is the market portfolio

CAPM assumptions:

▶ All investors are rational mean-variance optimisers.

▶ Investors care about returns measured over one period.

▶ All investors perceive the same means, variances and

covariances for returns (homogeneous expectations).

▶ There are no non-traded assets.

▶ Investors can take short positions in securities.

▶ There are no taxes or transactions costs

These assumptions imply that

1. All investors work with the same mean-stdev diagram.

2. All investors hold a portfolio on the mean-var efficient frontier.

3. Mutual fund theorem ⇒ all investors hold risky assets in the

same proportions.

4. All investors hold some combination of risk-free asset and the

tangency portfolio.

5. Demand = supply, so all investors must hold market portfolio,

i.e., value-weighted index that contains all risky assets in

proportion to their market value.

6. Market portfolio is mean-var efficient.

7. Market portfolio is the tangency portfolio.

▶ CAPM: market portfolio = tangency portfolio.

Exchange rated funds [ETF] - Cheaper than Index funds

Active vs passive funds

CAPM is in simple return not Log even though It uses [ ri ]

Regression

Time series regression

single asset- variance, std

Multiple assets or well diversed portfolio - beta

Market Portfolio will have a beta of 1

Interpreting a Positive and negative beta

Chain Rule

The capital market line (CML) represents portfolios that optimally combine risk and return.

A risk-free rate is the rate of return that investors require for investments with no risks

CAPM - shows the relationship between the expected return on an investment and market risks

the bar represents an estimate

the market estimate will help to estimate the assets estimate

seminar

principle of participation - questionnaire

The tangency portfolio is the market portfolio all investors assumed to be a mean-variance optimiser

mutual fund theorem = says nothing about risk-free assets. look at the composition of the risky proportion and It should be the same

Alpha of stocks is the difference in returns

higher sm** = higher slope = higher beta = riskier