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Chapter 18CAPITAL ASSET PRICING THEORY What is the capital market line (CML)?

How is the Capital Asset Pricing Model(CAPM) developed?

What is the difference between thestandard deviation risk and beta riskmeasures?

How can an investor apply the CAPM tosecurity analysis?

How do you estimate beta?

What are the good news and the bad news

about beta?

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Assumptions of the Capital

Asset Pricing Model Investors have homogeneous

expectations

Frictionless capital markets

Investors are rational and seek tomaximize their expected utility functions

Investment is for one-period only All investors can borrow or lend at the

riskfree rate

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Efficient frontier and the

optimal risky portfolio Developing the capital market line

(CML)

Introducing the riskfree asset.

The capital market line (CML) or theborrowing-lending line.

The Portfolio Separation Theorem

The market portfolio, M

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Figure 18.1 Efficient Frontier

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Figure 18.2 Efficient Frontier and UtilityCurves for Investors A and B

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Figure 18.3 Combinations of theRisk-Free Asset RF andRisky Portfolios P1 and P2

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Figure 18.4 Combinations of theRisk-Free Asset RF and

the Risky Portfolio M

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Figure 18.5 CML and Individual Utility Curves

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Figure 18.6 CML: The Borrowing-Lending Line

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Capital Asset Pricing Model

Developing a relative risk measure

Understanding beta

Systematic risk or market risk

Diversifiable risk or firm-specific risk

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Figure 18.7 CML and Individual Securities

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CAPM derivation

Security risk and return

Reward for investing in a security

Security risk

Securitys reward-to-risk ratio

Risk/return relationship

The security market line (SML)

Differences between the CML and SML

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Figure 18.8 Security Market Line (SML)

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CAPM and security analysis

Estimating the required return.

Estimating the predicted return.

Security analysis decision rule.

Comparison with fundamental

analysis.

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Estimating Beta

Security characteristic line

Information service beta estimates

Calculating beta: Separatingsystematic risk from diversifiable

risk. Differences between the SML and the

security characteristic line

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Good news and bad news

about Beta How reliable are beta estimates?

Does beta really measure risk?

The verdict on beta.

Implications for investors

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Figure 18.9 Security Market Line Analysis

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Figure 18.10 Regression Analysis toEstimate Beta