Essentials of Investments: Chapter 7 - Capital Asset Pricing and Arbitrage Pricing Theory

Essentials of Investments: Chapter 7 - Capital Asset Pricing and Arbitrage Pricing Theory presents Capital Asset Pricing Model, Resulting Equilibrium Conditions, Capital Market Line, Slope and Market Risk Premium, Expected Return and Risk on Individual Securities. | 1 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Chapter 7 Capital Asset Pricing and Arbitrage Pricing Theory Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc. All rights reserved. 2 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Capital Asset Pricing Model (CAPM) • Equilibrium model that underlies all modern financial theory • Derived using principles of diversification with simplified assumptions • Markowitz, Sharpe, Lintner and Mossin are researchers credited with its development Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc. All rights reserved. 3 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Assumptions • Individual investors are price takers • Single-period investment horizon • Investments are limited to traded financial assets • No taxes, and transaction costs Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc. All rights reserved. 4 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Assumptions (cont.) • Information is costless and available to all investors • Investors are rational mean-variance optimizers • Homogeneous expectations Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc. All rights reserved. 5 Bodie • Kane • Marcus Essentials of Investments Fourth Edition Resulting Equilibrium Conditions • All investors will hold the same portfolio for risky assets – market portfolio • Market portfolio contains all securities and the proportion of each security is its market value as a percentage of total market value Irwin / McGraw-Hill © 2001 The McGraw-Hill Companies, Inc. All rights .

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