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Chapter 10 Return and Risk: The CapitalAsset-Pricing Model (CAPM)
10-1
Fifth
Edition
Corporate
Finance
.
.
Ross
Westerfield
Jaffe
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10.1 Individual Securities
10.2 Expected Return, Variance, and Covariance
10.3 The Return and Risk for Portfolios
10.4 The Efficient Set for Two Assets
10.5 The Efficient Set for Many Securities
10.6 Diversification: An Example
10.7 Riskless Borrowing and Lending
10.8 Market Equilibrium
10.9 Relationship between Risk and Expected Return
(CAPM)
 10.10 Summary and Conclusions
 Appendix 10A: Is Beta Dead?
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Expected (Ex Ante) Return, Variance, and
Covariance
10-2
Fifth
Edition
Corporate
Finance
.
.
Ross
 Expected Return: E(R) = S (ps x Rs)
 Variance: s2 = S {ps x [Rs - E(R)]2}
 Standard Deviation = s
 Covariance: sAB = S {ps x [Rs,A - E(RA)] x [Rs,B -
E(RB)]}
 Correlation Coefficient: rAB = sAB / (sA sB)
Westerfield
Jaffe
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Return and Risk for Portfolios (2 Assets)
10-3
Fifth
Edition
Corporate
Finance
.
.
 Expected Return of a Portfolio:
E(Rp) = XAE(R)A + XB E(R)B
 Variance of a Portfolio:
sp2 = XA2sA2 + XB2sB2 + 2 XA XB sAB
Ross
Westerfield
Jaffe
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
An Example of Portfolio Return and Risk
10-4
Fifth
Edition
Corporate
Finance
Stock
Investment
IBM
$5000
HM
$5000
Total
$10000
 sIBM,HM = 0
Xi E.(Ri)
50%
0.09
50%
0.13
100%
si2
0.01
0.04
 E[Rp] = (0.5)(0.09) + (0.5)(0.13) = 11%
 sp2 =(.5)2(.01) + (.5)2(.04) + 2(.5)(.5)(0) = 0.0125
 sp = (0.0125)(1/2) = 0.1118
.
.
Ross
Westerfield
Jaffe
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Efficient Sets and Diversification
10-5
Fifth
Edition
Corporate
Finance
r = -1
E(R)
-1 <
r<1
r =1
MV
MV
MV
.
.
s
Ross
Westerfield
Jaffe
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Capital Market Line
10-6
Fifth
Edition
Corporate
Finance
.
.
Expected return
of portfolio
.
.
M
4
Risk-free
rate (Rf )
X
.
5
Y
.
Standard
deviation of
portfolio’s return.
Ross
Westerfield
Jaffe
Capital market line
Irwin/McGraw-Hill
© The McGraw-Hill Companies, Inc., 1999
Security Market Line
10-7
Fifth
Edition
Corporate
Finance
.
.
Expected return
on security (%)
.
Rm
Rf
Ross
M
.
0.8
Westerfield
Jaffe
Security market
line (SML)
Irwin/McGraw-Hill
.
T
S
1
Beta of
security
© The McGraw-Hill Companies, Inc., 1999