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SAPM Assignment
Submitted By
Raju Saw Roll No.- 2010102

[Year]

Question 1
Expected return Stock A Stock B Stock C Market portfolio 19 4 14 15 Standard deviation 19.07878403 15.62049935 10.44030651 13.89244399

Question 2
A &B Cov Securities b/t -296 A&C 199

Question 3
Coefficient correlation A&B of -0.993221486 A&B 0.999054397

Question 4
when equally weighted p 2 E(R)p E(R)p 11.50% 12.00% When weight of A=.4,B=.4 p 9.422101676 & C=.2

Question 5
It shows relation b/t risk and expected return for an inefficient security is expressed by the Security market line. E(R) Stock A Stock B Stock C 19 4 14 1.2 -0.7 0.9 required return 16.8 6 6 2.2 -2 8

required return 16.8 6 6

Stock A Stock B Stock C risk

portfolio or a Single

market premium 9

Question 6
2M CovDM 54.7 83.9 1.533821

Question 7
Capital Market Line - CML The CML is derived by drawing a tangent line from the intercept point on the efficient frontier to the point where the expected return equals the risk-free rate of return. The CML is considered to be superior to the efficient frontier since it takes into account the inclusion of a risk-free asset in the portfolio. The capital asset pricing model (CAPM) demonstrates that the market portfolio is essentially the efficient frontier. This is achieved visually through the security market line (SML).

Security Market Line - SML SML is the line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky marketable securities.

It is also referred to as the "characteristic line". The SML essentially graphs the results from the capital asset pricing model (CAPM) formula. The x-axis represents the risk (beta), and the y-axis represents the expected return. The market risk premium is determined from the slope of the SML.

The security market line is a useful tool in determining whether an asset being considered for a portfolio offers a reasonable expected return for risk. Individual securities are plotted on the SML graph. If the security's risk versus expected return is plotted above the SML, it is undervalued because the investor

can expect a greater return for the inherent risk. A security plotted below the SML is overvalued because the investor would be accepting less return for the amount of risk assumed. Relationship between SML and CML The CML is a special case of SML. We may demonstrate it as follows

As per SML Since =

( )
Eq (1)can we written as

(
(

. . . . . (1)

SML

( )

. . . . . . . . (2)

If the returns on i and M are perfectly correlated Eq (2) becomes

( )

. . . . . . . . (3)

This is nothing but the CML. Hence the CML is a special case of the SML.

Question 8
Systematic Risk The risk that is inherent to the entire market or entire market segment. Interest rates, recession and wars all represent sources of systematic risk because they affect the entire market and cannot be avoided through diversification. Whereas this type of risk affects a broad range of securities, unsystematic risk affects a very specific group of securities or an individual security. Systematic risk can be mitigated only by being hedged. Even a portfolio of well-diversified assets cannot escape all risk. Unsystematic Risk

The unsystematic risk of a security represents the portion of risk which is firm specific factors like the development of a new product, a labor strike, or the emergence of a new competitor. This is a company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through appropriate diversification. For example, news that is specific to a small number of stocks, such as a sudden strike by the employees of a company you have shares in, is considered to be unsystematic risk. It is also known as "specific risk", "diversifiable risk", unique risk or "residual risk". Total risk associated with a investment i, as measured by its variance, is the sum of two components; (1) systematic risk that is (2) Unsystematic risk that is &

Question 9
The Capital Asset Pricing Model is an exercise in positive economics. It is concern with two things:1) What is the relationship between risk and return for an efficient portfolio? 2) What is the relationship between risk and return for an individual security? While CAPM represents a seminal contribution to the field of finance many empirical studies have pointed toward its defenses in explaining the relationship between risk and returns. Since the markets are inefficient for extended periods of time, the Arbitraging Pricing Theory has been developed. APT which is reasonably intuitive, requires only limited assumptions, and allows for multiple risk factors. Unlike the CAPM, the APT does not specify a priori what the underlying risk factors are so, a test of APT calls for first discovering the basic risk factors by employing multivariate techniques like factor analyses and then examining whether these basic risk factors corresponds to some economic or behavioral variables.

Comparison of CAPM & APT

Nature of relation No. of risk factors Factor risk premium Factor risk sensitivity Zero beta return CAPM Linear 1 ( ) i APT Linear K j bij 0