# Howard College Capital Market

CAPITAL MARKET THEORY DISCUSSION

“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 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      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%.

• 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:
• Weight of the risk-free securities and the equity       portfolio.
• The blended portfolio expected returns.

The blended portfolio risk.

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.

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?

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

appropriate for a conservative investor and one for an aggressive

investor.