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| − | The picture below depicts a set of possible investment '''''portfolios'''''. The risk of a portfolio comprises systematic risk, also known as [[Undiversifiable Risk|Undiversifiable Risk]], and unsystematic risk which is also known as [[Diversifiable Risk|Diversifiable Risk]], usually proxied by the standard deviation of the portfolio's return. Undiversifiable risk refers to the risk common to all securities which is the market risk.
| + | Portfolio Theory and the Capital Asset Pricing Model |
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| − | * <math>r_M</math> is the '''average market risk'''
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| − | * <math>{\sigma}_M</math> is the '''average variance on the market risk'''
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| − | * <math>r_F</math> is the '''[[Risk free rate of return|Risk free rate of return]]'''
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| − | * The red dot in the picture marks the '''full market portfolio'''
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| − | * The '''Efficient set''' (the blue line) represents the '''biggest return possible''' for each given risk profile
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| − | The CAPM assumes that the risk-return profile of a portfolio can be optimized - an optimal portfolio displays the lowest possible level of risk for its level of return.
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| − | <html><img src = "/static/files/MBI/Module%2013/CAPM.png" width="800"/></html>
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| − | By adding a risk free asset to a portfolio, one can reduce risk:
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| − | <html><img src = "/static/files/MBI/Module%2013/CAPM_riskfree.png" width="800"/></html>
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| − | By borrowing and increasing your portfolio you can increase return:
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| − | <html><img src = "/static/files/MBI/Module%2013/CAPM_borrowing.png" width="800"/></html>
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| − | By doing both 1) and 2) we get the Capital Market Line:
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| − | <html><img src = "/static/files/MBI/Module%2013/CAPM_capitalmarketline.png" width="800"/></html>
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| | [[Category:finance]] | | [[Category:finance]] |
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Revision as of 18:39, 27 August 2020
Portfolio Theory and the Capital Asset Pricing Model
