Last Modified: 2011-10-10
combination of risk free and risky portfolio creates CAL - tangency with indifference curve is optimal portfolio
have different preferences based on indifference curve - Tobin
uses portfolio theory and simplified assumptions
allows for pricing securities - relationship between risk and return
*indentify over/under priced securities
*evaluate capital budgeting decisions
1realized returns 2proxies market/risk free 3time period
investments limited to traded assets, unlimited borrowing and lending
single period investment horizon
investors are rational, mean-variance, and utility maximizers
investors passively hold portion of M and risky asset
risk premium too low - excess supply, prices fall, returns rise
provides benchmark for evaluating performance
SML gives required rate of return that compensates investors for the risk of the investment
it tests the market model with a proxy for the market, not true "CAPM"
they offered a three factor alternative
will yield profit in the future
if opportunity exists, investors will take advantage until the prices change and opportunity no longer exists
if alpha doesn't equal zero then opportunity exists
borrow money at risk free rate and invest in portfolio
must be well diversified portfolio
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