Modern Portfolio Theory

- There is no risk free security

- Risk of a p/f is dep upon the covariance between the security

Capital Market Theory – was given by W. Sharpe, Lintner

- There exists a risk free security

- Investor combines the r-f security with the risky assets

When a risk free security is combined with risky assets then the locus of portfolios can be given by a
line which is called – capital market line

Assumptions

- All investors can lend and borrow at risk free security’s rate of interest
- All investors have similar expectations of the risk and return of different securities
- CMT works in equilibrium i.e. perfect coherence
- Stock is divisible
- Holding period is one year
- No capital gain tax, no transactions cost, no dividend tax
- There is no inflation
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