# Howard College Capital Market Theory Discussion and Responses

CAPITAL MARKET THEORY DISCUSSION

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

Initial Post – 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 Â Â Â Â Â the equity portfolio.

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

Assume a risk-free rate of 5%.

• Create a table with data to illustrate nine different Â Â Â Â Â blended portfolios, ranging from 100% risk free to 100% equity to 200% Â Â Â Â Â equity (which assumes buying on margin). Include your table in your post. Â Â Â Â Â The table should include the following:Â
• Weight of the risk-free securities and the equity Â Â Â Â Â Â portfolio.
• The blended portfolio expected returns.

The blended portfolio risk.

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

Label the optimal market portfolio M.

• Label the 100% bond portfolio B.
• Label the section of the capital market line that Â Â Â Â Â 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 Â Â Â Â Â to the assumed optimal portfolio M. Does this 20-security equity portfolio Â Â Â Â Â approximate the optimal portfolio? Why or why not?

Response guidelineCalculate the risk premium for the market portfolio on your classmateâ€™s graph. Explain the meaning of the risk premium.Calculate the slope of the capital market line (CML) line on your classmateâ€™s graph and explain what the slope means.Identify one portfolio on your classmateâ€™s graph that would beÂ

appropriate for a conservative investor and one for an aggressiveÂ

investor.Â

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