Week 6: Portfolio Theory
Capital Asset Pricing Model (CAPM)
Asset allocation between risky and risk- free assets
Asset allocation with two or more risky assets
Efficient diversification with risk- free and many risky assets
Ri = Rf + (Rm - Rf)*Bi
Bi = cov(Ri,Rm)/ var(Rm)
WACC
Complete portfolio
E(Rc) = wE(Rp) + (1-w)E(Rf)
Combination without leverage
Combination with leverage
Risk aversion and asset allocation
greater risk aversion => larger proportions of risk- free rate
assumptions on investors and expected utility (p.17)
Passive strategies and the CAPM
Active vs Passive Strategies (p.20)
passive strategy: investing in a broad stock index and a risk- free investment
Combinations of risky assets
Covariance and correlation
Portfolio variance and standard deviation
The Efficient Frontier
Minimum variance combinations