1. Discuss the progression of the Markowitz portfolio model into the capital mar

Question

1. Discuss the progression of the Markowitz portfolio model into the capital market theory (p. 367)

2. Describe what is meant by the security market line being the graphic representation of the capital asset pricing model (pp. 368-369)

3. Contrast the differences between option writing and option buying (pp. 370-371)

4. Why isn’t the Black-Scholes option model based upon an American style option? (p. 374)

5. Briefly explain how the “January effect” anomaly contradicts the efficient market hypothesis or theory (p. 397)

Explanation / Answer

Markowitz portfolio discusses the mean variance analysis such that expected return is maximised for a given risk or variance of the asset. The model assumes risk aversice nature of the investors and that two portfolios offer same returns then they shall pick less risky ones. But an investor who woild like to have more return would accept an investment with more risky assets . This means that portfolio combinations are a result of returns on assets. The fluctuations are a function of correlations Pij for all assets i and j . The security market line represents expected return and systemic risk to show how the market must price individual securities in relation to their security classes .It helps to calculate return to risk ratio in the overall market analysis.The beta coeeficient explains expected return on the asset c) option writing refers to the seller one who wites an option and decides the terms and future payment of the exchange . Option buyer is obligated to purchase but not exercise it at the time of fuuture payment . d) Black scholes model is based on derivative instruments deriving the asset value from other assets in the market .It is used for no arbitrage bounds and risk neutral pricing methods which is different from american style options .

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