Question

wg uestIon. TOur answer or each part should be no longer, than two pages long. (a) How does the security market line differ from the capital market line? Explain your answer. (b) Compare and contrast the minimum variance frontier with the efficient frontier. Can it ever be the case that the minimum variance and efficient frontiers are the same? Explain your answer. (c) Compare and contrast Treynor and Sharpe performance measures. What is Sharpe's rationale for using standard deviation risk and not beta risk? Explain your answer. (d) What assumption of the CAPM is relaxed to develop the zero-beta portfolio model? Show algebraically that zero-beta portfolios plot on the inefficient frontier. (e) Hearth and Zaima (2004) conclude that "The multifactor APT model is more robust than the CAPM because if allows for several factors that may affect security returns and it avoids the need to identify a truc market portfolio". Explain why you cither agree/disagree with their assertion.

sorry the question says answer 3 out of the 5. C,D,E please

Answer 1

ANSWER C --

The Sharpe measure uses the standard deviation of returns as the measure of risk, while the Treynor measure employs beta (systematic risk). The Sharpe measure, therefore, implicitly evaluates the portfolio manager on the basis of return performance, but also takes into account how well diversified the portfolio was during this period. If a portfolio is perfectly diversified (does not contain any unsystematic risk), the two measures would give identical rankings because the total variance of the portfolio would be a systematic variance.If a portfolio is poorly diversified, it is possible for it to have a high ranking on the basis of Treynor measures, but a much lower ranking on the basis of Sharpe measure. Any difference should be directly attributable to the poor diversification of the portfolio.Therefore, the two measures provide complementary but different information and both measures should be derived.

The Sharpe ratio uses standard deviation to measure a fund's risk-adjusted returns. The higher a fund's Sharpe ratio, the better a fund's returns have been relative to the risk it has taken on. Because it uses standard deviation, the Sharpe ratio can be used to compare risk-adjusted returns across all fund categories. The higher a fund's standard deviation, the higher the fund's returns need to be to earn a high Sharpe ratio. Conversely, funds with lower standard deviations can sport a higher Sharpe ratio if they have consistently decent returns. Keep in mind that even though a higher Sharpe ratio indicates a better historical risk-adjusted performance, this doesn't necessarily translate to a lower-volatility fund. A higher Sharpe ratio just means that the fund's risk/return relationship is more proportional or optimal.

ANSWER D--

A zero-beta portfolio is a portfolio constructed to have zero systematic risk or, in other words, a beta of zero. A zero-beta portfolio would have the same expected return as the risk-free rate.

A zero-beta portfolio is one that lies on the inefficient part of the frontier (the lower half of the curve below the minimum variance portfolio) that corresponds to a portfolio on the efficient part (upper half), which is in this case, the market portfolio. The two portfolios have the same variance.

ANSWER E--

APT is more accurate than CAPM since CAPM only looks at one factor and one beta, but it requires additional effort and time not only to calculate but also to determine what factors to use and to gather relevant data to find the beta in relation to each factor. On the other hand, it is not always possible to know the right factors or to find the right data, which is when CAPM may be preferred.

As a result, the decision of whether to use CAPM vs. APT should largely be dependent on whether you can actually determine the right factors to use and find the data to find the beta in relation to those factors in order to use APT, or if you are willing to settle for just knowing the difference between the risk-free rate of return and the expected market rate of return as you would if you use CAPM.

A big difference between CAPM and the arbitrage pricing theory is that APT does not spell out specific risk factors or even the number of factors involved. While CAPM uses the expected market return in its formula, APT uses the expected rate of return and the risk premium of a number of macroeconomic factors. The APT formula uses a factor-intensity structure that is calculated using a linear regression of historical returns of the asset for the specific factor being examined.

The Arbitrage Pricing Theory (APT) is much more robust than the capital asset pricing model for several reasons: The APT makes no assumptions about the empirical distribution of asset returns. There is no special role for the market portfolio in the APT, whereas the CAPM requires that the market portfolio be efficient.