Flashcards in Topic 5: Asset Pricing Models Deck (23)

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1

## How is the CAPM derived and what does it show?

###
- Derived using principles of diversification with simplified assumptions

- Showing the relationship between risk and

expected return of an asset

2

## What researchers are credited with its development?

### Markowitz, Sharpe, Lintner and Mossin

3

## What are the first 3 assumptions of the CAPM?

###
1) Individual investors are price takers

2) Single-period investment horizon (ignoring anything that might happen afterwards)

3) Investments are limited to traded financial assets (can borrow or lend at risk-free rate)

4

## What are the last 4 assumptions of the CAPM?

###
4) No taxes and transaction costs

5) Investors are rational mean-variance optimizers

6) There are homogeneous expectations

7) Information is costless and available to all investors

5

## What is the market portfolio?

###
- Market portfolio contains all securities and the proportion of each security is its market value as a percentage of total market value

6

## What does CAPM assume about risk premiums?

###
- assumes that appropriate risk premium on an asset will be determined by its contribution to the risk of investors’ overall portfolios

7

## The variance of the portfolio is .......?

### - The sum of all elements

8

## What does beta measure?

### - Beta measures the stock’s contribution to the variance of the market portfolio

9

## what does the CML graph?

### - CML graphs the risk premiums of efficient portfolios as a function of portfolio standard deviation

10

## What does the SML graph?

### - SML graphs individual asset risk premiums as a function of asset risk; the measure of risk for individual assets held as parts of well-diversified portfolios is the contribution of the asset to the portfolio variance (beta)

11

## How can CAPM be used to analyse securities?

### - portfolio manager will increase the weights of securities with positive alphas and decrease the weights of securities with negative alphas

12

## How is CAPM is useful in project or asset valuation?

### - useful in asset or project valuation by providing required rate of return (NPV valuation; DDM valuation)

13

## Is the condition of zero alphas for all stocks as implied by the CAPM met?

### - Not perfect but one of the best available

14

## is CAPM testable?

### - Proxies must be used for the market portfolio

15

## Is CAPM still considered one of the best available description of security pricing and is widely accepted

### - Yes

16

## Whats the difference between beta in CAPM and beta in single index model?

### - They look the same, however, CAPM measures expected returns, while single index model measures real/historical returns

17

##
The CAPM states that the expected value of alpha

should be what for all securities?

### - Zero

18

##
The index model

holds that the realized value of alpha should

average out to _____ for a sample of historical

observed returns

### - Zero

19

## What does 'm' stand for in the two different models?

###
- In single index model, “m” stands for a market

index

- In CAPM, “m” stands for the whole market, which consists of all securities in the market

20

## How can arbitrage arise?

###
- arises if an investor can construct a

zero investment portfolio with a sure profit

- Since no investment is required, an investor can create large positions to secure large levels of profit

21

## Unlike CAPM, what does APT not assume?

###
- Single-period investment horizon

- Absence of personal taxes

- Risk-free borrowing or lending

- Mean-variance decisions

22

## Whats the most important thing with the APT model?

### - the deviations of the factors from their expected values.

23