FIN2101 BUSINESS FINANCE II
FIN2101 BUSINESS FINANCE II
Module 2 Capital asset Pricing model (CAPM)
Module 2 Capital Asset Pricing Model (CAPM)
Student activities Reading a Text, Chapter 6(pp. 210-21 only Text Study Guide, Chapter 6(part only a Study Book, Module 2(inC. Appendices 2.1, 2.2& 2.3 Tutorial Work a Tutorial w orkbook, self Assessment Activity 2.1 Text Study Guide, Chapter 6, T/F9& 10, MC 13 to 15 Problems 5.7&8
Student Activities Reading ◼ Text, Chapter 6 (pp. 210-21 only) ◼ Text Study Guide, Chapter 6 (part only) ◼ Study Book, Module 2 (inc. Appendices 2.1, 2.2 & 2.3) Tutorial Work ◼ Tutorial Workbook, Self Assessment Activity 2.1 ◼ Text Study Guide, Chapter 6, T/F 9 & 10, MC 13 to 15, Problems 5, 7 & 8
Capital asset pricing model I CAPM describes how prices of individual securities are determined ■ Portfolio theory. An asset's return is equal to the risk-free rate plus a risk premium equal to the asset's beta multiplied by the market risk premium a Linear relationship between return and risk
Capital Asset Pricing Model ◼ CAPM describes how prices of individual securities are determined. ◼ Portfolio theory. ◼ An asset’s return is equal to the risk-free rate plus a risk premium equal to the asset’s beta multiplied by the market risk premium. ◼ Linear relationship between return and risk
Risk and return Return is a function of risk a Higher risk warrants a higher return Return= Risk-free return risk premium
Risk and Return ◼ Return is a function of risk ◼ Higher risk warrants a higher return ◼ Return = Risk-free return + risk premium
Risk Total risk: unsystematic risk systematic risk unique risk market risk diversifiable risk non-diversifiable risk
Risk Total risk: = unsystematic risk + systematic risk = unique risk + market risk = diversifiable risk + non-diversifiable risk
Expected Return-Single asset X Pr
Expected Return - Single Asset n i=1 i Pri k = k
Risk- Single asset k:-k)×P k -k O,=111=1 n-1
Risk - Single Asset ( ) = = n i 1 i 2 k ki - k Pr ( ) n -1 k - k n i 1 2 i k = =
Expected Return risk of a Portfolio w:× k p Ok,=wiO1+w202+2W,W252O, 02
Expected Return & Risk of a Portfolio n j =1 p j j k = w k 1 2 1,2 1 2 2 2 2 2 2 1 2 k 1 w w 2w w r p = + +
Correlation coefficient a measure of the relation between the returns on two securities Can be t or-or o Diversification is of greatest benefit in risk reduction when the correlation between the returns on the two securities is negative
Correlation Coefficient ◼ A measure of the relation between the returns on two securities. ◼ Can be + or - or 0. ◼ Diversification is of greatest benefit in risk reduction when the correlation between the returns on the two securities is negative