Professional Documents
Culture Documents
Principles of
Corporate Finance
Tenth Edition
Portfolio Theory
and the Capital
Asset Model
Pricing
Slides by
Matthew Will
McGraw-Hill/Irwin
Topics Covered
Harry Markowitz And The Birth Of
Portfolio Theoryy
The Relationship Between Risk and Return
Validity and the Role of the CAPM
Some Alternative Theories
8-2
8-3
Proporrtion of Days
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-7 -6
-5 -4
-3 -2
-1
Daily % Change
8-4
8-5
% probability
16
14
12
10
8
6
4
2
0
-50
50
% return
% probability
16
14
12
10
8
6
4
2
0
-50
% return
50
8-6
8-7
% probability
16
14
12
10
8
6
4
2
0
-50
50
% return
Boeing
8
7
6
40% in Boeing
5
4
3
Campbell Soup
2
1
0
0,00
5,00
10,00
15,00
Standard Deviation
20,00
25,00
8-8
Efficient Frontier
8-9
Expected
Standard
Return
Deviation
A
100
Amazon.com
22.8%
50.9%
19.1
10.9
Ford
19.0
47.2
19.9
11.0
Dell
13.4
30.9
15.6
10.3
Starbucks
9.0
30.3
13.7
10.7
Boeing
9.5
23.7
9.2
10.5
8.8
3.6
Disney
7.7
19.6
Newmont
7.0
36.1
9.9
11.2
10.2
ExxonMobil
4.7
19.1
9.7
18.4
Johnson &
3.8
12.6
7.4
33.9
3.1
15.8
8.4
33.9
Johnson
Soup
22.8
14.1
10.5
4.2
50.9
22.0
16.0
8.8
Efficient Frontier
4 Efficient Portfolios all from the same 10 stocks
8-10
Efficient Frontier
8-11
Each half egg shell represents the possible weighted combinations for two
stocks.
The composite of all stock sets constitutes the efficient frontier
Expected Return (%)
Standard Deviation
Efficient Frontier
Lending or Borrowing at the risk free rate (rf) allows us to exist outside the
efficient frontier.
Expected Return (%)
rf
T
Standard Deviation
8-12
Efficient Frontier
Book Example
Stocks
Campbell
15.8
Boeing
23.7
8-13
Efficient Frontier
Another Example
Stocks
ABC Corp
28
Big Corp
42
Correlation Coefficient = .4
% of Portfolio
Avg Return
60%
15%
40%
21%
8-14
Efficient Frontier
Another Example
Stocks
ABC Corp
28
Big Corp
42
8-15
Correlation Coefficient = .4
% of Portfolio
Avg Return
60%
15%
40%
21%
Efficient Frontier
Previous Example
Stocks
Portfolio
28.1
New Corp
30
8-16
Correlation Coefficient = .3
% of Portfolio
Avg Return
50%
17.4%
50%
19%
Efficient Frontier
Previous Example
Stocks
Portfolio
28.1
New Corp
30
8-17
Correlation Coefficient = .3
% of Portfolio
Avg Return
50%
17.4%
50%
19%
Efficient Frontier
8-18
Return
B
A
Risk
(measured as
)
Efficient Frontier
8-19
Return
B
AB
A
Risk
Efficient Frontier
8-20
Return
B
AB
A
Risk
Efficient Frontier
8-21
Return
B
ABN AB
A
Risk
Efficient Frontier
8-22
Goal is to move
up and left.
Return
WHY?
B
ABN AB
A
Risk
Efficient Frontier
The ratio of the risk premium to
the standard deviation is called the
Sharpe ratio:
Sharpe
p Ratio =
8-23
Goal is to move
up and left.
WHY?
rp rf
Efficient Frontier
8-24
Return
Low Risk
High Risk
High Return
High Return
Low Risk
High Risk
Low Return
Low Return
Risk
Efficient Frontier
8-25
Return
Low Risk
High Risk
High Return
High Return
Low Risk
High Risk
Low Return
Low Return
Risk
Efficient Frontier
8-26
Return
B
ABN AB
A
Risk
8-27
Return
Market Return = rm
.
Market Portfolio
rf
(Treasury bills)
Risk
8-28
Return
Market Return = rm
.
Market Portfolio
rf
(Treasury bills)
1.0
BETA
8-29
Return
.
Risk Free
Return
rf
BETA
SML
rf
1.0
BETA
SML Equation = rf + B ( rm - rf )
8-30
8-31
r = rf + B(rm rf )
CAPM
Expected Returns
These estimates of the returns expected by investors in
February 2009 were based on the capital asset pricing model.
We assumed 0.2% for the interest rate r f and 7% for the
expected risk premium r m r f .
TABLE 8.2
Stock
Beta ()
Amazon
Ford
Dell
Starbucks
Boeing
Disney
Newmont
ExxonMobil
Johnson & Johnson
Soup
2.16
1.75
1.41
1.16
1.14
.96
.63
.55
.50
.30
Expected Return
[rf + (rm rf)]
15.4
12.6
10.2
8.4
8.3
7.0
4.7
4.2
3.8
2.4
8-32
SML Equilibrium
8-33
In equilibrium no stock can lie below the security market line. For
example, instead of buying stock A, investors would prefer to lend part
of their money and put the balance in the market portfolio. And instead
of buying stock B
B, they would prefer to borrow and invest in the
market portfolio.
SML
Investors
12
Market
Portfolio
1.0
Portfolio Beta
8-34
8-35
Investors
SML
Market
Portfolio
Portfolio Beta
1.0
8-36
Dollars
(log scale)100
2008
10
0.1
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
2006
1996
1986
1976
1966
1956
1946
1936
1926
8-37
Alternative to CAPM
Return = a + b1 (rfactor1 ) + b2 (rfactor 2 ) + b3 (rfactor 3 ) + .... + noise
Real GNP
Inflation
Mrket
.49
- .83
6.36
8-38
8-39
Autos
Banks
Chemicals
Computers
Construction
Food
Oil and gas
Pharmaceuticals
Telecoms
Utilities
Three-Factor Model
Factor Sensitivities
.
bbook-tobmarket
bsize
market
1.51
.07
0.91
1.16
-.25
.7
1.02
-.07
.61
1.43
.22
-.87
1.40
.46
.98
.53
-.15
.47
0.85
-.13
0.54
0.50
-.32
-.13
1.05
-.29
-.16
0.61
-.01
.77
Expected
return*
15.7
11.1
10.2
6.5
16.6
5.8
8.5
1.9
5.7
8.4
CAPM
Expected
return**
7.9
6.2
5.5
12.8
7.6
2.7
4.3
4.3
7.3
2.4
The expected return equals the risk-free interest rate plus the factor
sensitivities multiplied by the factor risk premia, that is, rf + (bmarket x 7) +
(bsize x 3.6) + (bbook-to-market x 5.2)
** Estimated as rf + (rm rf), that is rf + x 7.
8-40
Web Resources
Click to access web sites
Internet connection required
http://finance.yahoo.com
www.duke.edu/~charvey
http://mba.tuck.dartmouth.edu/pages/faculty/ken.french
8-41