Elton Chapter 14:Nonstandard Forms of Capital Asset Pricing Models - Video Tutorial

[Dr. Jayanthi Sankaran]

Hi David,

Just a small observation - I am positive it is a typo, but nevertheless, I thought I would bring it to your attention. In page 36 of the Video Tutorial, on the RHS instead of 'Riskless Lending and Borrowing', it should have been 'No Riskless Lending and Borrowing'.

Thanks!

 

[David Harper CFA FRM]

Hi @Jayanthi Sankaran yes, absolutely. Thank you (This video will be updated for 2015 and this chapter won't apply, FWIW). Thank you!

 

[Dr. Jayanthi Sankaran]

Hi David,

Hope you and your family, had a great Thanksgiving! As far as the above post goes, does it mean that we are responsible only for Chapters 5 and 13 of Elton and Gruber? Can we safely eliminate Chapter 14? Also, I have the Eight edition, and not the Ninth (I am positive that there will be no changes!). Also, what is FWIW? Not good with Acronyms!

 

[David Harper CFA FRM]

Hi @Jayanthi Sankaran Thank you for saying that, I had an awesome Thanksgiving (I visited a dear friend in Sante Fe, NM). I hope you enjoyed the holiday!

• Re: are we are responsible only for Chapters 5 and 13 of Elton and Gruber? Can we safely eliminate Chapter 14?
  Yes, you can ignore Nonstandard forms of CAPM (Chapter 14). Now that we have the 2015 syllabus, we can observe that (again), strictly speaking only Standard CAPM (Chapter 13) is assigned. But again, we will retain Chapter 5 in the update because it is useful prequel.
  
• Re: I have the Eight edition, and not the Ninth: Yes, you are fine. I don't see any differences with respect to Chapter 5 and 14; even if there has been and edits (which i do not see), they would be immaterial. These chapters are essentially unchanged between the versions; and the concepts are definitely unchanged.

what is FWIW: sorry, "for what it's worth." I use that when I'm writing something that is an aside, sort of to mean "I am mentioning this but it's minor or off-topic but might be interesting"

Thanks!

 

[Dr. Jayanthi Sankaran]

Hi David.

Happy to note that you had a great Thanksgiving! Thanksgiving is not a National holiday in India, because it is primarily a Hindu country. However, I suspect that Christians (who are a minority) do celebrate it, although I am not quite sure, because we did not have the Pilgrims like immigrants flock to India. We do have a lot of National holidays, though, like Diwali (Festival of Lights) and Independence/Republic Holidays (when India gained Independence from the British!). Christmas is celebrated in a Major way, though nowhere like the US.

• Re: Will look up Chapter 5 of Elton - finished with your material
• Thanks for the clarification of the Eighth and Ninth Edition of Elton
• Getting better with understanding Acronyms, one of my friends in Canada specializes in them...and some of them are quite funny!

Thanks!

 

[David Harper CFA FRM]

Hi @Jayanthi Sankaran awesome. I am actually not very facile with all the young folks' acronyms, but here is my secret weapon (fwiw!): http://www.urbandictionary.com/

 

[Dr. Jayanthi Sankaran]

Hi David,

Thanks for sharing your secret weapon - Never heard of 'I feel your nuts' - rather nutty, I must say! Only Americans can come up with something like that - can't fathom a staid Britisher doing that....Nevertheless - good learning!

Have a question for you on page 74 of Elton Chapter 5:

• Figure 5.2 - when rho = -1 between C and S, there is one portfolio with zero sigma which is the ultimate in diversification and hedging. Can this be equated to a riskless asset such as a T-bill or T-bond (although the latter does have inflation risk)?
• How do I type the symbols for rho and sigma?

Thanks!

 

[Bionic Turtle Super Admin]

Hi @Jayanthi Sankaran

• Great observation! As Figure 5.2 shows, under the unrealistic (but academically common) assumption of perfect negative correlation, there is a solution for the two-asset portfolio that has zero standard deviation. But this two-asset portfolio is different than the riskless asset in the framework. At first glance, it appears to engender a fallacy: this two-asset portfolio, if perfectly mixed, will have an expected return somewhere between the two risky assets. In the Elton example, E(C) = 14% and E(S) = 8%, such that 1/3rd allocated to C produces the riskless portfolio with return = 10.0% (i.e., the y-intercept). But that must be greater than the return of the riskless asset. They are similar insofar as they both have zero standard deviation, but they are not the same .... I'm going to post a contest question: why isn't this a fallacy or problem; i.e., isn't this a free lunch?
• Apparently, you can use ALT+[ASCII code], but I can never get that to work myself. So here comes another tip: I use http://www.phraseexpress.com/ (it has some competitors which may be good/better, but i've been using this for years). This allows me to copy the symbols and associate them text-based shortcuts, so I only need to use the text-based shortcuts. But it's useful far beyond that.

Thanks!

 

[Dr. Jayanthi Sankaran]

Hi David,

• Thanks! I have gone through the perfect negative correlation case (Figure 5.2) all over again. You have mentioned 'As Figure 5.2 shows, under the unrealistic (but academically common) assumption of perfect negative correlation, there is a solution for the two-asset portfolio that has zero correlation' - I presume you meant perfect negative correlation, instead of zero.
• Also, 'In the Elton example, E(C) = 14% and E(S) = 8%, such that 1/3rd allocated to C produces the riskless portfolio with return = 8.0% (i.e., the y-intercept)' - I presume you meant return = 10.0% (i.e., the y-intercept).
• As far as Figure 5.2 goes, it deals with combinations of two 'risky' assets - we have not yet reached the case of inclusion of a 'risk-free' asset.
• As far as US markets go, the expected return on the riskless portfolio is definitely higher than the T-bill rate. But this does not necessarily apply to emerging market (say, India) Government bonds (Mmmm....have to think about that one...interesting thought, though!)
• As far as the www.phraseexpress.com site goes, really don't know, how to go about doing this...

Thanks a tonne!

 

[Bionic Turtle Super Admin]

Hi @Jayanthi Sankaran Sorry, my sloppy mistakes:

• I meant: with perfect negative correlation, there is a solution for a portfolio with zero standard deviation (the minimum variance portfolio)
• Yes, I should have said the Y-intercept is 10%. Corrected above. Thanks!

 

[Dr. Jayanthi Sankaran]

No problem - Thanks, David!

 

[VINCENTP]

Hi David,
as Elton chapter 5 was discontinued in 2014 and not included in 2015 GARP study guides, do I need to master and solve all the problems for this chapter?
For chapter 14, I learned from your reply to Jayanthi that we could safely ignore it. Thanks, David.

 

[Dr. Jayanthi Sankaran]

Hi Vincent,

As David mentioned above, although you can safely ignore Chapter 14 (Nonstandard forms of the CAPM), it is important that you go through Chapter 5 of Elton......It provides the fundamental background to Chapter 13. It would be useful to get acquainted with the problems, too! Happy studying.....

Jayanthi