CAPITAL ASSET PRICING MODEL

Investors have homogeneous expectations. There is a one-period time horizon.BASIC ASSUMPTIONS Investors hold efficient portfolios. Capital markets are in equilibrium. . Investments are infinitely divisible. Unlimited borrowing and lending are available at the risk-free rate. higher expected returns involve higher risk. Inflation is fully anticipated. No taxes or transaction costs exist.

Capital Market Line: linear risk-return trade-off for all investment portfolios Security Market Line: linear risk-return trade-off for individual stocks .

EFFICIENT FRONTIER Rp C B A 0 p .

CAPITAL MARKET LINE Rp Lending Portfolio Borrowing Portfolio S Rf p .

SECURITY MARKET LINE Rp SML S Er Rf X 1 Beta .

FORMULAE CML y Rp = Rf Xf + Rm (1-Xf) SML y E(Ri) = Rf + i [E(Rm) ² Rf ] .

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