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1、,Principles of Corporate FinanceSeventh EditionRichard A.Brealey Stewart C.Myers,Slides byMatthew Will,Chapter 8,McGraw Hill/Irwin,Copyright 2003 by The McGraw-Hill Companies,Inc.All rights reserved,Risk and Return,Topics Covered,Markowitz Portfolio TheoryRisk and Return RelationshipTesting the CAPM
2、CAPM Alternatives,Markowitz Portfolio Theory,Combining stocks into portfolios can reduce standard deviation,below the level obtained from a simple weighted average calculation.Correlation coefficients make this possible.The various weighted combinations of stocks that create this standard deviations
3、 constitute the set of efficient portfolios.,Markowitz Portfolio Theory,Price changes vs.Normal distributionMicrosoft-Daily%change 1990-2001,Proportion of Days,Daily%Change,Markowitz Portfolio Theory,Standard Deviation VS.Expected ReturnInvestment A,%probability,%return,Markowitz Portfolio Theory,St
4、andard Deviation VS.Expected ReturnInvestment B,%probability,%return,Markowitz Portfolio Theory,Standard Deviation VS.Expected ReturnInvestment C,%probability,%return,Markowitz Portfolio Theory,Standard Deviation VS.Expected ReturnInvestment D,%probability,%return,Markowitz Portfolio Theory,Coca Col
5、a,Reebok,Standard Deviation,Expected Return(%),35%in Reebok,Expected Returns and Standard Deviations vary given different weighted combinations of the stocks,Efficient Frontier,Standard Deviation,Expected Return(%),Each half egg shell represents the possible weighted combinations for two stocks.The
6、composite of all stock sets constitutes the efficient frontier,Efficient Frontier,Standard Deviation,Expected Return(%),Lending or Borrowing at the risk free rate(rf)allows us to exist outside the efficient frontier.,rf,Lending Borrowing,T,S,Efficient Frontier,Example Correlation Coefficient=.4Stock
7、ss%of PortfolioAvg ReturnABC Corp2860%15%Big Corp42 40%21%Standard Deviation=weighted avg=33.6 Standard Deviation=Portfolio=28.1 Return=weighted avg=Portfolio=17.4%,Efficient Frontier,Example Correlation Coefficient=.4Stockss%of PortfolioAvg ReturnABC Corp2860%15%Big Corp42 40%21%Standard Deviation=
8、weighted avg=33.6 Standard Deviation=Portfolio=28.1 Return=weighted avg=Portfolio=17.4%Lets Add stock New Corp to the portfolio,Efficient Frontier,Example Correlation Coefficient=.3Stockss%of PortfolioAvg ReturnPortfolio28.150%17.4%New Corp30 50%19%NEW Standard Deviation=weighted avg=31.80 NEW Stand
9、ard Deviation=Portfolio=23.43 NEW Return=weighted avg=Portfolio=18.20%,Efficient Frontier,Example Correlation Coefficient=.3Stockss%of PortfolioAvg ReturnPortfolio28.150%17.4%New Corp30 50%19%NEW Standard Deviation=weighted avg=31.80 NEW Standard Deviation=Portfolio=23.43 NEW Return=weighted avg=Por
10、tfolio=18.20%NOTE:Higher return&Lower risk How did we do that?DIVERSIFICATION,Efficient Frontier,A,B,Return,Risk(measured as s),Efficient Frontier,A,B,Return,Risk,AB,Efficient Frontier,A,B,N,Return,Risk,AB,Efficient Frontier,A,B,N,Return,Risk,AB,ABN,Efficient Frontier,A,B,N,Return,Risk,AB,Goal is to
11、 move up and left.WHY?,ABN,Efficient Frontier,Return,Risk,Low RiskHigh Return,High RiskHigh Return,Low RiskLow Return,High RiskLow Return,Efficient Frontier,Return,Risk,Low RiskHigh Return,High RiskHigh Return,Low RiskLow Return,High RiskLow Return,Efficient Frontier,Return,Risk,A,B,N,AB,ABN,Securit
12、y Market Line,Return,Risk,.,rf,Risk Free Return=,Efficient Portfolio,Security Market Line,Return,.,rf,Risk Free Return=,Efficient Portfolio,BETA,1.0,Security Market Line,Return,.,rf,Risk Free Return=,BETA,Security Market Line(SML),Security Market Line,Return,BETA,rf,1.0,SML,SML Equation=rf+B(rm-rf),
13、Capital Asset Pricing Model,R=rf+B(rm-rf),CAPM,Testing the CAPM,Avg Risk Premium 1931-65,Portfolio Beta,1.0,SML,3020100,Investors,Market Portfolio,Beta vs.Average Risk Premium,Testing the CAPM,Avg Risk Premium 1966-91,Portfolio Beta,1.0,SML,3020100,Investors,Market Portfolio,Beta vs.Average Risk Pre
14、mium,Testing the CAPM,High-minus low book-to-market,Return vs.Book-to-Market,Dollars,Low minus big,http:/mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html,Consumption Betas vs Market Betas,Stocks(and other risky assets),Wealth=marketportfolio,StandardCAPM,ConsumptionCAPM,Arbitrage Pricing Theory,Alternative to CAPMExpected Risk Premium=r-rf=Bfactor1(rfactor1-rf)+Bf2(rf2-rf)+Return=a+bfactor1(rfactor1)+bf2(rf2)+,Arbitrage Pricing Theory,Estimated risk premiums for taking on risk factors(1978-1990),
