Chapter 8

PORTFOLIO THEORY AND THE

CAPITAL ASSET PRICING MODEL

Brealey, Myers, and Allen

Principles of Corporate Finance
11th Global Edition
McGraw-Hill Education Copyright 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
 The content of this chapter has been
abbreviated to focus only on the application
of CAPM in determining the required rate of
return.

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8-2 THE RELATIONSHIP BETWEEN RISK AND
RETURN
Capital Asset Pricing Model (CAPM)

r rf (rm rf )
Where:
r = required rate of return
rf = risk-free rate of return
rm = market rate of return
(rm-rf) = market risk premium

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TABLE 8.2 ESTIMATES OF RETURNS
Returns estimates in January 2012 based on capital asset pricing
model. Assume 2% for interest rate rf and 7% for expected risk
premium rm rf.

Stock Beta Expected Return

Dow Chemical 1.78 14.50
Bank of America 1.54 12.80
Ford 1.53 12.70
ExxonMobil 0.98 8.86
Starbucks 0.95 8.68
IBM 0.80 7.62
Newmont Mining 0.75 7.26
Pfizer 0.66 6.63
Walmart 0.42 4.92
Heinz 0.40 4.78

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FIGURE 8.7 SECURITY MARKET LINE EQUILIBRIUM
In equilibrium, no stock can lie below the security market line

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FIGURE 8.8 CAPITAL ASSET PRICING MODEL

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FIGURE 8.9B BETA VERSUS AVERAGE RETURN

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RESEARCH IMPLICATION

Test of CAPM
Test of 3-factor model (pp 206-208)
Test of stability of beta
Tests of Fama-French model

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