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Lecture

Principles of Finance: CAPM and Portfolio Management

In course

MGT-482: Principles of finance

The course provides a market-oriented framework for analyzing the major financial decisions made by firms. It provides an introduction to valuation techniques, investment decisions, asset valuation, financing decisions, and sustainable finance. ...

Description

This lecture covers the Capital Asset Pricing Model (CAPM), which measures non-diversifiable risk with beta and translates it into expected returns. It explains the implications of CAPM on risk premiums, security market line, and alpha. The lecture also delves into the efficient portfolio, market risk, and the impact of news on portfolio efficiency.

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Instructor

Erwan Morellec

ERWAN MORELLEC is Swiss Finance Institute Professor and Professor of Finance at the Ecole Polytechnique Fédérale de Lausanne (EPFL), Switzerland. He is also the Head of the SFI Léman Centre, the Head of the SFI nation-wide PhD Program, and a CEPR Research Fellow. Formerly on the faculties of the Simon School of Business of the University of Rochester (USA) and HEC Lausanne (Switzerland), he holds a Ph.D. in Finance from HEC Paris. Professor Morellec is most active in the areas of corporate finance and banking and has taught several courses on these subjects to undergraduate, MBA, and doctoral students. His recent research examines the effects of prudential regulation on banks' insolvency risk or the effects of financial market imperfections on corporate investment, financing, and risk management decisions. His research has been presented at major academic conferences and seminar series around the world and is published in top rated academic journals such as the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, and the Journal of Economic Theory. He has received several research and teaching awards.

Official source

Ontological neighbourhood

Business

Finance: Corporate finance

Business administration: Risk management

Economics

Microeconomics: Financial economics

Related concepts (32)

Capital asset pricing model

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

Modern portfolio theory

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return.

Security market line

Security market line (SML) is the representation of the capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk. The risk of an individual risky security reflects the volatility of the return from security rather than the return of the market portfolio. The risk in these individual risky securities reflects the systematic risk. The Y-intercept of the SML is equal to the risk-free interest rate.

Risk premium

A risk premium is a measure of excess return that is required by an individual to compensate being subjected to an increased level of risk. It is used widely in finance and economics, the general definition being the expected risky return less the risk-free return, as demonstrated by the formula below. Where is the risky expected rate of return and is the risk-free return. The inputs for each of these variables and the ultimate interpretation of the risk premium value differs depending on the application as explained in the following sections.

Financial risk

Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent. A science has evolved around managing market and financial risk under the general title of modern portfolio theory initiated by Harry Markowitz in 1952 with his article, "Portfolio Selection".

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