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Introduction To Capital Market Theory Formula Sheet For Final Exam

This document provides formulas and definitions for key concepts in capital market theory, portfolio management, and asset pricing models. It includes formulas for portfolio expected return and risk with one or two risky assets, as well as the CAPM, Fama-French Three Factor Model, APT, and Single Index models. It also defines formulas for active and passive portfolio management, including optimal portfolio weights, expected returns, and risk measures for evaluating portfolio performance like the Sharpe ratio, Treynor's ratio, Jensen's alpha, and information ratio.

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Rishi Bigghe
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© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
38 views

Introduction To Capital Market Theory Formula Sheet For Final Exam

This document provides formulas and definitions for key concepts in capital market theory, portfolio management, and asset pricing models. It includes formulas for portfolio expected return and risk with one or two risky assets, as well as the CAPM, Fama-French Three Factor Model, APT, and Single Index models. It also defines formulas for active and passive portfolio management, including optimal portfolio weights, expected returns, and risk measures for evaluating portfolio performance like the Sharpe ratio, Treynor's ratio, Jensen's alpha, and information ratio.

Uploaded by

Rishi Bigghe
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Introduction to Capital Market Theory

Formula Sheet for Final Exam

One risky asset plus risk free asset

a *x

E (rx ) r f
A x2

Two risky assets


E(rp) = ax E(rx) + (1- ax) E(ry)

p2 =ax2 x2 + (1- ax)2 y2 + 2ax(1- ax) xy x y.


Cov(rx, ry)= xy x y

y2 xy x y
a

A( x2 y2 2 xy x y ) ( x2 y2 2 xy x y )
E (rx ) E (ry )

*
x

Hedging demand

ax

y2 xy x y
( x2 y2 2 xy x y )

Two risky assets and risk free asset


The optimal risky portfolio is defined as follows

Fx*

[ E (rx ) r f ] y2 [ E (ry ) r f ] xy x y

[ E (rx ) r f ] y2 [ E (ry ) r f ] x2 [ E (rx ) r f ] [ E (ry ) r f ] xy x y

CAPM

E (ri ) r f iM [ E (rM ) r f ]

Ri ri r f E Ri i E RM
i

Cov(ri , rm )

m2

E ( P1 ) Cov( P1 , rm )
P0

1 rf

E (rm ) rf

m2

Fama French Three Factor model


(ri rf) = i + i (rm rf) +si(SMB) + hi(HML) + ei

SMB = small minus big = rsmall rbig , HML = high B/M minus low B/M = rvalue rglamour

si stocks sensitivity to size factor, hi stocks sensitivity to B/M factor,

Arbitrage Pricing Theory

~
~
If returns follow a k factor return generating process, rit E (ri ) i1F1t i 2 F2t ...ik Fkt eit
and there are arbitrage opportunities, then , E (ri ) rf 1i1 2 i 2 ....k ik
where i are the factor risk premia.
Single Index Model

Ri t i i RM t ei t

ij i j M2

ij iM jM

Active Passive Portfolio Management

wi*

(ei )
, i 1..n
i
2 (e )
i
2

A wi i

A wi i

wA0

(e A )
2

E ( RM )

w*A

M2

0
A

w
,
1 (1 A ) wA0

wM (1 w*A ),


s P s M (eAA )
2

Portfolio Evaluation
Sharpe Measure

Treynors Measure

rp rf

Jensesns

p R p p RM

rp rf

Adjusted Treynor Ratio

Information ratio/Appraisal Ratio

p
(e p )

p
p

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