An Alternative View of Risk and Return: The Apt: Mcgraw-Hill/Irwin Corporate Finance, 7/E
An Alternative View of Risk and Return: The Apt: Mcgraw-Hill/Irwin Corporate Finance, 7/E
An Alternative View of Risk and Return: The Apt: Mcgraw-Hill/Irwin Corporate Finance, 7/E
CHAPTER
11
An Alternative View of Risk
and Return: The APT
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-1
Chapter Outline
11.1 Factor Models: Announcements, Surprises, and
Expected Returns
11.2 Risk: Systematic and Unsystematic
11.3 Systematic Risk and Betas
11.4 Portfolios and Factor Models
11.5 Betas and Expected Returns
11.6 The Capital Asset Pricing Model and the
Arbitrage Pricing Theory
11.7 Parametric Approaches to Asset Pricing
11.8 Summary and Conclusions
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-2
n
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-7
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-8
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-9
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-14
Excess Ri - Ri = βi F + εi
return
If we assume
that there is no
unsystematic
i risk, then i = 0
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-16
Excess
return
If we assume
Ri - Ri = βi F that there is no
unsystematic
risk, then i = 0
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-17
Excess
return βA =1.5 βB = 1.0
Different
securities will
βC = 0.50 have different
betas
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-18
RP = X1 R1 + X 2 R2 + L + Xi Ri + L + X N RN
Ri = Ri + βi F + εi
RP = X1 ( R1 + β1 F + ε1 ) + X2 ( R2 + β2 F + ε2 ) +
L + X N ( RN + βN F + εN )
RP = X1 R1 + X1 β1 F + X1 ε1 + X2 R2 + X 2 β2 F + X 2 ε2 +
L + X N RN + X N βN F + X N εN
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-19
RP = X1 R1 + X 2 R2 + L + X N RN
+ ( X1 β1 + X 2 β2 + L + X N βN ) F
RP = X1 R1 + L + X N RN + ( X1 β1 + L + X N βN ) F
RP βP
Recall that and
RP = X1 R1 + L + X N RN βP = X1 β1 + L + X N βN
The return on a diversified portfolio is the sum of the
expected return plus the sensitivity of the portfolio to the
factor.
RP = RP + βP F
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-22
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-23
Expected return
SML
D
A B
RF
C
R = RF + β ( RP - RF )
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-24
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
11-26
R = R + βI FI + βGDP FGDP + βS FS + ε
As securities are added to the portfolio, the unsystematic risks of
the individual securities offset each other. A fully diversified
portfolio has no unsystematic risk.
The CAPM can be viewed as a special case of the APT.
Empirical models try to capture the relations between returns and
stock attributes that can be measured directly from the data
without appeal to theory.
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.