Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Chapter 10 Return and Risk: The Capital- Asset-Pricing Model (CAPM)  10.1 Individual Securities  10.2 Expected Return, Variance, and Covariance  10.3 The Return and Risk for Portfolios  10.4 The Efficient Set for Two Assets  10.5 The Efficient Set for Many Securities  10.6 Diversification: An Example  10.7 Riskless Borrowing and Lending  10.8 Market Equilibrium  10.9 Relationship between Risk and Expected Return (CAPM)  Summary and Conclusions  Appendix 10A: Is Beta Dead?

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Expected (Ex Ante) Return, Variance, and Covariance  Expected Return: E(R) =  (p s x R s )  Variance:  2 =  {p s x [R s - E(R)] 2 }  Standard Deviation =   Covariance:  AB =  {p s x [R s,A - E(R A )] x [R s,B - E(R B )]}  Correlation Coefficient:  AB =  AB / (  A  B )

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Return and Risk for Portfolios (2 Assets)  Expected Return of a Portfolio: E(R p ) = X A E(R) A + X B E(R) B  Variance of a Portfolio:  p 2 = X A 2  A 2 + X B 2  B X A X B  AB

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield An Example of Portfolio Return and Risk Stock InvestmentX i E.(Ri)  i 2 IBM$500050% HM$500050% Total$ %   IBM,HM = 0  E[R p ] = (0.5)(0.09) + (0.5)(0.13) = 11%   p 2 =(.5) 2 (.01) + (.5) 2 (.04) + 2(.5)(.5)(0) =   p = (0.0125) (1/2) =

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Efficient Sets and Diversification  E(R)  = <   = 1 MV

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Capital Market Line Expected return of portfolio Standard deviation of portfolio’s return. Risk-free rate (R f ) 4 M. 5.. Capital market line. X Y

Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 Corporate Finance Fifth Edition Ross Jaffe Westerfield Security Market Line Expected return on security (%) Beta of security RmRm RfRf 0.81 S M T... Security market line (SML)