Capital Asset Pricing Model (Capm)vs.Arbitrage Pricing Theory (Apt).

887 Words Jul 5th, 2008 4 Pages
CAPM vs. APT
Asset Pricing Model are very useful tools that enable financial annalists or just simply independent investors evaluate the risk in an specific investment and at the same time set a specific rate of return with respect the amount of risk of an individual investment or a portfolio. The CAPM method while simpler than the ATP method takes into consideration the factor of time and does not get too wrapped up over the Systematic risk factors that sometimes we can not control. In this paper, I will explain some of the advantages and disadvantages of the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT).
These are tow methods that while different from each other, they try to explain and provide the same
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“The beauty of the APT is that it is possible to select assets in a portfolio on the basis of the very fundamentals that determine the timing and volume of consumption needs of the investor.”2
Now, lets take a look at the Capital Asset Pricing Model (CAPM) method. This is my favorite of the two for various reasons. It gives a measure to the systematic risk (Beta) that while is not controllable; having a measurement puts into perspective the risk to return ratio. When talking about the CAPM we have to assume that the return on a stock depends on whether the stock's price follows prices in the market as a whole. The more the stock follows the market (higher Beta) the more return we should expect form the investment.
The CAPM divides the risk into two parts: systematic (market) and unsystematic
1 & 2. Even Otuteye (1998). The arbitrage pricing dichotomy. Retrieved http://proquest.umi.com/pqdweb?index=0&did=413172211&SrchMode=1&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1187652743&clientId=29440
(diversifiable). When using the CAPM we could conclude that it is a very simple but comprehensive way to obtain critical information about a specific investment. For example, the beta factors, if not available for an investment, it could easily be calculated using the same CAPM formula (Ks = Krf + B (Km - Krf)). The CAPM method does not individually point out some of the macroeconomic factors
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