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© K. Cuthbertson and D. Nitzsche Figures for Chapter 5 Mean-Variance Portfolio Theory and CAPM (Quantitative Financial Economics)
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© K. Cuthbertson and D. Nitzsche Standard Deviation 25-304512... Note : 100%=risk when holding only one asset 100% 40% Figure 1 : Random Selection of Stocks Diversifiable / Idiosyncratic / Specific Risk Non-diversifiable / Market Risk No of stocks in portfolio
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© K. Cuthbertson and D. Nitzsche = -0.5 Figure 2 : Expected Return and Standard Deviation
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© K. Cuthbertson and D. Nitzsche X Y = 0.5 = 0 = -0.5 = -1 BA Z C = +1 Figure 3 : Efficient Frontier and Correlation
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© K. Cuthbertson and D. Nitzsche ER p pp x x x x x x x x x x x x x x x x B A C P1P1 P1P1 x L U p* = 10% p** = 9% p** p* Figure 4 : Efficient and Inefficient Portfolios
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© K. Cuthbertson and D. Nitzsche Expected Return, N RR Standard Deviation, N X L Q Z Borrowing/ leverage Lending r all wealth in risky asset all wealth in risk-free asset Figure 5 : Transformation Line
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© K. Cuthbertson and D. Nitzsche ER Capital Market Line r A K M ER m ER m - r IBIB IAIA Y Z’ mm Q L Figure 6 : Portfolio Choice
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© K. Cuthbertson and D. Nitzsche Expected Return CML M m - r Y mm Standard Deviation B A L Figure 7 : Market Portfolio
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© K. Cuthbertson and D. Nitzsche Required return = SML and actual return = SML Asset’s beta, i Q (buy) S (sell) P actual return expected return 0.511.2 T (sell) M Securities which lie above (below) the SML have a positive (negative) ‘alpha’ indicating a positive (negative) ‘abnormal return’, after correcting for ‘beta risk’. r Q >0 S < 0 Figure 8 : Security Market Line, SML
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