1. Figure 7.1 Efficient Frontier and Capital Market Line

2. 7.1 The Capital Asset Pricing Model

3. 7.1 The Capital Asset Pricing Model

4. Figure 7.2 The SML and a Positive-Alpha Stock

5. 7.2 CAPM and Index Models

6. 7.2 CAPM and Index Models

7. Table 7.1 Monthly Return Statistics 01/06 - 12/10
T-Bills
S&P 500
Google
Average rate of return
0.184
0.239
1.125
Average excess return -
0.055
0.941
Standard deviation*
0.177
5.11
10.40
Geometric average
0.180
0.107
0.600
Cumulative total 5-year return
11.65
6.60
43.17
Gain Jan 2006-Oct 2007
9.04
27.45
70.42
Gain Nov 2007-May 2009
2.29
-38.87
-40.99
Gain June 2009-Dec 2010
0.10
36.83
42.36
* The rate on T-bills is known in advance, SD does not reflect risk.

8. Figure 7.3A: Monthly Returns

9. Figure 7.3B Monthly Cumulative Returns

10. Figure 7.4 Scatter Diagram/SCL: Google vs. S&P 500, 01/06-12/10

11. Table 7.2 SCL for Google (S&P 500), 01/06-12/10
Linear Regression
Regression Statistics R
0.5914
R-square
0.3497
Adjusted R-square
0.3385
SE of regression
8.4585
Total number of observations 60
Regression equation: Google (excess return) = × S&P 500 (excess return)
ANOVA df SS MS F
p-level
Regression 1
31.19
0.0000
Residual 58
71.55
Total 59
Coefficients
Standard Error
t-Statistic
p-value
LCL
UCL
Intercept
0.8751
1.0920
0.8013
0.4262
3.4877
S&P 500
1.2031
0.2154
5.5848
0.6877
1.7185
t-Statistic (2%)
2.3924
LCL - Lower confidence interval (95%)
UCL - Upper confidence interval (95%)

12. 7.2 CAPM and Index Models Estimation results
Security Characteristic Line (SCL)
Plot of security’s expected excess return over risk-free rate as function of excess return on market
Required rate = Risk-free rate + β x Expected excess return of index

13. 7.4 Multifactor Models and CAPM

14. 7.4 Multifactor Models and CAPM

15. Table 7.3 Monthly Rates of Return, 01/06-12/10
Monthly Excess Return % *
Total Return
Security
Average
Standard Deviation
Geometric Average
Cumulative Return
T-bill
0.18
11.65
Market index **
0.26
5.44
0.30
19.51
SMB
0.34
2.46
0.31
20.70
HML
0.01
2.97
-0.03
-2.06
Google
0.94
10.40
0.60
43.17
*Total return for SMB and HML
** Includes all NYSE, NASDAQ, and AMEX stocks.

16. Table 7.4 Regression Statistics: Alternative Specifications
 Regression statistics for:
1.A Single index with S&P 500 as market proxy
1.B Single index with broad market index (NYSE+NASDAQ+AMEX)
2. Fama French three-factor model (Broad Market+SMB+HML)
Monthly returns January December 2010
Single Index Specification
FF 3-Factor Specification
Estimate
S&P 500
Broad Market Index
with Broad Market Index
Correlation coefficient
0.59
0.61
0.70
Adjusted R-Square
0.34
0.36
0.47
Residual SD = Regression SE (%)
8.46
8.33
7.61
Alpha = Intercept (%)
0.88 (1.09)
0.64 (1.08)
0.62 (0.99)
Market beta
1.20 (0.21)
1.16 (0.20)
1.51 (0.21)
SMB (size) beta -
-0.20 (0.44)
HML (book to market) beta
-1.33 (0.37)
Standard errors in parenthesis

17. 7.5 Arbitrage Pricing Theory
Calculating APT
Returns on well-diversified portfolio

18. Table 7.5 Portfolio Conversion
Steps to convert a well-diversified portfolio into an arbitrage portfolio
*When alpha is negative, you would reverse the signs of each portfolio weight to achieve a portfolio A with positive alpha and no net investment.

19. Table 7.6 Largest Capitalization Stocks in S&P 500
Weight
Stock
Weight

20. Table 7.7 Regression Statistics of S&P 500 Portfolio on Benchmark Portfolio, 01/06-12/10
Linear Regression
Regression Statistics R
0.9933
R-square
0.9866
Adjusted R-square
0.9864
Annualized
Regression SE
0.5968
2.067
Total number of observations 60
S&P 500 = × Benchmark
Coefficients
Standard Error
t-stat
p-level
Intercept
0.0771
0.0163
Benchmark
0.9337
0.0143
0.0000

21. Table 7.8 Annual Standard Deviation
Period
Real Rate
Inflation Rate
Nominal Rate
1/1 / /31/10
1.46
0.61
1/1/ /31/00
0.57
0.54
0.17
1/1/ /31/90
0.86
0.83
0.37

22. Figure 7.5 Security Characteristic Lines

23. 7.5 Arbitrage Pricing Theory
Multifactor Generalization of APT and CAPM
Factor portfolio
Well-diversified portfolio constructed to have beta of 1.0 on one factor and beta of zero on any other factor
Two-Factor Model for APT

24. Table 7.9 Constructing an Arbitrage Portfolio
Constructing an arbitrage portfolio with two systemic factors

25. Figure 8.1 Cumulative Abnormal Returns before Takeover Attempts: Target Companies

26. Figure 8.2 Stock Price Reaction to CNBC Reports

27. Figure 8.3 Average Annual Return: Ten Size-Based Portfolios, 1926-2010

28. Figure 8.4 Average Annual Return as Function of Book-to-Market Ratio, 1926-2010

29. Figure 8.9 Risk-Adjusted Performance in Ranking Quarter, Following Quarter