Sharpe Single Index Model

Stock

Prices are related to market index

Return

for a security can be represented by the following equation:

Ri = i + i I + ei where Ri = expected return on Security I i = intercept of st line or alpha coefficient i = beta coefficient I = expected return on index or market ei = error term

Security returns correlated with market/ index

= 8.5

Y = 8.5 0.5x

Security Return

Return on Index

Portfolio Return and Risk

Portfolio return Portfolio Risk: Total Risk = Systematic Risk + Unsystematic Risk Systematic Risk = 2 (Variance of Index) Unsystematic Risk = Total Risk Systematic Risk

Rp = Xi (i + i I)

SHARPE OPTIMAL PORTFOLIO

The

selection of any stock is directly related to its excess return to Beta ratio

(Ri - Rf) / i
Rank

the securities to be possibly included in the portfolio according to this ratio. Determine C for each security and also C* Find the weightage of each security