🙋 Section/Student Qs for Exam 1

Agenda for Saturday Section, July 13 ✅

• At this point, having done the review session, we focus primarily on student questions.
• Office Hours. Click here for notes and timestamps. Email office hour questions to robecon1452@gmail.com and I will cover them next section.

Click here to learn about timestamps and my process for answering questions.

📅 Questions covered Saturday, July 13

🕣
❔ Message: Can Beta be negative?
Page URL: https://1452.robmunger.com/l3/2000/

✔ Yes. See: https://s1452.netlify.app/l3/capmfaq/#betanegative

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❔ Message: Can you cover Q11 in the HW? If the simple CAPM is valid, is the situation shown below possible?
Page URL: https://1452.robmunger.com/l3/2000/

✔ We covered this during the solution review listed in the agenda, above.

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❔ Message: Can the graduate paper be a an analysis of a single stock?
Page URL: https://1452.robmunger.com/l0/gradpapers/

✔ Only if you can relate your analysis to one of the topics covered in the lecture. The grad papers need to connect to a topic from the lecture. For example, we’ve discussed option trading, so you maybe you could analyze RobinHood.

🕣 4:12
❔ Message: About this question:

Suppose 𝑟𝑓=1%, r=1%, 𝛽=1.1, and the market risk premium is 11%. If you expect a stock to be worth $100 in 1 year and you expect a$4 dividend, what is the fair price for the stock today?

Why are we subtracting the risk-free rate to 11% if 11% is the market risk premium? Isn’t the market risk premium already including into consideration the risk free rate? Looking back at the “Notes on CAPM from E2000”, E(rM)-rF is defined as the market’s risk premium.

I really appreciate any help you can provide.
Page URL: https://1452.robmunger.com/l3/capmdivhpr/

✔ Thank you! Rewritten.

🕣 4:12
❔ Message: Can we calculate SD in portfolio with an option strategy?
Page URL: https://1452.robmunger.com/l4/section4/

✔ I’m not sure if I fully understand this question. I think you’re asking if you can calculate the SD of a porfolio if it contains an option strategy. If so, yes, you can. You just calculate the SD based on the price history of the various components/legs of the option strategy. In this way, you can calculate the SD for portfolios made of any securities that are liquid and transparent enough that they have accurate daily prices.

🕣 4:13
❔ Message: Could you discuss the contradictions to the semi-strong form of the EMH?

✔ Anything in which people use publicly available information to make risk-adjusted excess profits from trading/investing would be a contradiction to the semi-strong form.

• If people can make risk-adjusted excess profits from ① buying small companies, ② companies with low P/E ratio, companies with high book/price ratios, ③ momentum companies, etc. that contradicts SS EMH (Semi-strong EMH)
• If you’re just brilliant and pick stocks well, so you can make risk-adjusted excess profits, that contradicts SS EMH. (as long as you weren’t using inside information)
• basically, anything where you make risk-adjusted excess profits violates the SS EMH

🕣 4:17
❔ Message: options at the money will always have intrinsic value equal to zero?
Page URL: https://1452.robmunger.com/l5/section5/

✔ Yes.

🕣 4:18
❔ Message: If option is at expiration will have zero time value? what if in the money?
Page URL: https://1452.robmunger.com/l5/section5/

✔ Generally, we would expect that options at expiration will have close to zero time value. If they are in the money they will have a positive IV and a TV that approaches zero. If it has intrinsic value, then the premium should equal the intrinsic value.

🕣 4:21
❔Risk premium on an individual security: a function of the covariance of returns with the asset that make up the market portfolio

what does this mean

✔ The risk premium for a security is determined by β.

Beta, as we have discussed earlier (it’s really helpful! - But you don’thave to memorize it), is

$$\begin{aligned} β &= \frac{Cov(r_M,r_i)}{σ_M\,σ_i} \\ &= \frac{σ_i}{σ_M}\rho_{i,M} \end{aligned}$$

Based on this formula, Beta, is “a function of” $Cov(r_M,r_i)$. This term is the covariance of the returns of the asset ($r_i$) with the returns of the market portfolio ($r_M$)”

🕣
❔ SML vs CAL vs CML

✔ SML helps you visualize how β is related to $E(r_i)$, so it’s different from the other two, which help you understand how σ is related to $E(r_i)$. The SML is only for the CAPM, and it’s essentially a graph of the CAPM equation: $E(r_i)=r_F+β(E(r_M)-r_F)$

The CAL and CML are basically the same thing. They both are versions of the graph from the capital allocation decision lecture. They both show the relationship between $E(r_C)$ and $σ_C$. CML is just the special case in which your risky portfolio is the market portfolio. Ie where $r_M=r_C$.

🕣 4:35
❔expected return-beta relationship: the total expected rate of return is the sum of the risk-free plus a risk premium. what does this mean?

✔ This is used to explain the SML equation: $E(r_i)=r_F+β(E(r_M)-r_F)$. The return you get is the risk free rate, $r_F$ and a risk premium $E(r_M)-r_F$.

🕣
❔ give or take, CAPM is based on the insight that the risk premium on an asset is determined by its contribution to the risk of an investor’s overall portfolio. The amount an individual asset contributes to an investor’s overall portfolio.

what does the last sentence mean?

specifically, Is CAPM looking at one’s overall portfolio and market portfolio?

✔ covered in video

🕣
❔ Can we look at the graph of time value

✔ in video.

🕣
❔ Theory Multiple Choice

✔

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