UM Finance Discussion

Description

Prior to beginning work on this discussion forum, read Chapter 9, Capital Market Theory and Asset Pricing Models in the textbook Jones, C. P., & Jensen, G. R. (2020). Investments: Analysis and management (14th ed.).

Capital market theory is a positive theory in that it hypothesizes how investors do behave rather than how investors should behave (Jones & Jensen, p. 225, 2020). In this assignment, you will explore the implications of capital market theory on portfolio construction.

For the assignment, a new client has asked you to determine the portfolio weights for a blended portfolio of risk-free securities and a diversified equity portfolio, the optimal portfolio M.

For the purposes of this discussion

Set the expected rate of return between 10 and 14% for the equity portfolio.

Assume a standard deviation of 0.20, which approximates the historical standard deviation of the market.

Assume a risk-free rate of 5%.

In the assignment:

Create a table with data to illustrate nine different blended portfolios, ranging from 100% risk free to 100% equity to 200% equity (which assumes buying on margin). Include your table in your post. The table should include the following:

o Weight of the risk-free securities and the equity portfolio.

o The blended portfolio expected returns.

o The blended portfolio risk.

o Graph the capital market line of your equity and risk-free security portfolio. Plot portfolio risk on the x-axis and expected portfolio returns on the y-axis. Feel free to use Microsoft Excel to run these calculations.

Include your graph in your post, and on your graph, the following:

* Label the optimal market portfolio M.

* Label the 100% bond portfolio B.

* Label the section of the capital market line that involves buying the equity portfolio on margin.

Discuss the following:

*Explain what is meant by the market portfolio.

* Compare the equity portfolio you created in Stock-Trak to the assumed optimal portfolio M. Does this 20-security equity portfolio approximate the optimal portfolio? Why or why not?

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