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Capital Asset Pricing Model (CAPM)

The equation of the SML showing the relationship between expected return and beta.

Market Portfolio (M)

The portfolio for which each security is held in proportion to its total market value

Mutual Fund Theorem

The passive strategy of investing in a market index portfolio is efficient. A passive investor may view the market index as a reasonable first approximation of an efficient risky portfolio

Expected Return (mean return) beta relationship

Implication of the CAPM that security risk premiums (expected excess returns) will be proportional to beta

Security market line (SML)

a graphical representation of the CAPM with beta on the x-axis and expected return on the y-axis; slope of the line is the market risk premium (Rm - Rf)

Alpha

The difference between the fair and actually expected rates of return on a stock

Security characteristic line (SCL)

a plot of the excess return of a security on the excess return of the market, where Jensen's Alpha is the y-intercept and β is the slope

Multifactor Models

Models of security returns that respond to several systematic factors

Fama & French's Model

They say that the size of the company and the ratio of its market to book value were more useful in predicting future returns than beta

Arbitrage

Creation of riskless profits made possible by relative mispricing among securities

Arbitrage Pricing Theory (APT)

A theory of risk-return relationships derived from no-arbitrage considerations in large capital markets

Well-Diversified Portfolio

A portfolio sufficiently diversified that nonsystematic risk is small

Arbitrage Portfolio

A zero-net-investment, risk-free portfolio with a positive return

Factor Portfolio

A well-diversified portfolio constructed to have a beta of 1 on one factor and a beta of zero on any other factor

Nonsystemic Risk

Risk that is unique to a certain asset or company

CAPM Model Assumption

Basic assumption is that individuals are all alike except for wealth and risk tolerance