1. Graph of Efficient Frontier

 

E(R)

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2. The Risk Free Asset (Lending)

*Implications of adding the risk-free asset:

 

 

*The risk-free asset defined:

 

 

 

*Expected return and risk of a portfolio containing the risk-free asset:

 

 

 

 

 

 

 

*How does this change the efficient frontier?

 

3. The Risk Free Asset (Borrowing)

1. What is the correlation between the risk-free asset and the market portfolio?

 

 

 

 

2. What is the correlation between portfolio ‘i’ and the market portfolio assuming ‘i’ lies on the CML? HINT: What does ‘i’ consist of?

 

 

 

 

3. What happens to the CML when the risk-free rate changes?

1. The Capital Market Line (CML)

1. Tobin’s Separation Theorem

 

 

 

 

 

2. The Equation and the slope

*CML is applicable to:

*SML is applicable to:

*Relevant measure of risk:

1. Risk Redefined

*Types of risk:

*Beta (b ):

*Beta of the market:

*Aggressive stocks:

*Defensive stocks:

1. The Characteristic Line

R_i – R_rf

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_______________________________________________________R_m – R_rf

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2. Beta Calculated

b _j = COV_j,m /VAR_m

 

 

 

 

 

 

 

3. Beta of a Portfolio

1. Return Redefined

*Rates of return are a linear function of:

 

 

*E(R_j) = R_rf + b _j(E(R_m) – R_rf)

e.g.

 

 

 

 

 

 

*The above equation is called the:

 

 

 

*The slope of the SML is:

 

 

*The equation for the SML is:

 

 

 

 

 

 

 

 

 

E(R_i)

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R_rf |

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2. SML VS CML