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


What researchers are credited with its development?

Markowitz, Sharpe, Lintner and Mossin


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)


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


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


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


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

- The sum of all elements


What does beta measure?

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


what does the CML graph?

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


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)


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


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)


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

- Not perfect but one of the best available


is CAPM testable?

- Proxies must be used for the market portfolio


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

- Yes


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


The CAPM states that the expected value of alpha
should be what for all securities?

- Zero


The index model
holds that the realized value of alpha should
average out to _____ for a sample of historical
observed returns

- Zero


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

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

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


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


Unlike CAPM, what does APT not assume?

- Single-period investment horizon
- Absence of personal taxes
- Risk-free borrowing or lending
- Mean-variance decisions


Whats the most important thing with the APT model?

- the deviations of the factors from their expected values.


3 comparisons between APT and CAPM

- APT applies to well diversified portfolios and
not necessarily to individual stocks
- APT is more general in that it gets to an
expected return and beta relationship without
the assumption of the market portfolio
- APT can be extended to multifactor models