Capital Asset Pricing Model

An investor would invest in a security for the return. However that return comes with a premium, the Risk. The higher the risk an investor is willing to take the higher the returns would

In capital market, people are always seeking for the best investment project. They want to use the least cost to earn the most money. In another way, people always try to find the connection between the risk of an investment and its expected return. Nowadays, the most widely used model is CAPM. CAPM is Capital Asset Pricing Model. CAPM was funded by Jack Treynor (1962), William Sharpe (1964), John Lintner (1965a, b) and Jan Mossin (1966) (Dempsey, 2013). And it is the birth of asset pricing theory. The term ‘CAPM’ illustrates that it can give a proper solution to find the connection between risk and the expected return of the market portfolio under uncertainty conditions (Brealey, Myers and Allen, 2011). It is important for some researchers to help their decision making in capital market. This essay contains four parts. This essay examines firstly is giving a summary theory of CAPM. The second part will talk about the CAPM’s uses and limitations in evaluating the potential investment in a firm’s shares. The third part will talk about limitations and how CAPM to be used as a source of discount rate in capital budgeting for the firm’s direct investments. The forth part will give a conclusion about this essay.

Hint : Investors purchase assets based on a rational expectation of a stream of future income.

In the years since 2000, a few investors have determined that their small cap portfolio outperformed their shares held in larger companies in terms of ROI (return on investment). The total dollar price earned was lesser; nevertheless the benefit percentage was

Financial theory accepts the belief that a share’s return should be proportional to the risk received by its holder. There is a need of a risk-return equilibrium model. Since the nativity of the efficient market hypothesis (EMH), an equilibrium model was only the Capital Asset Pricing Model (CAPM). The CAPM constitutes of two types of returns, the risk free rate of returns of the Treasury bills and beta times the return on the market portfolio. The following equation is the basis of this model:

An investment can be defined in several ways. First, we’ll have a look at the financial implications of the

This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk

Moreover, although small stocks outperform large stocks in the past several years, we should not expect small stocks to outperform large stocks in the future, because, in the future stock market, there’re quite a lot uncertainty, either, we might find the situation that a small stock can only outperform a large stock in a specific period (i.e. government may promote some specific industry) or it contains

• Compare and contrast the concepts of risk, return and the opportunity cost of capital and how these concepts are applied in a real-world context.

The efficient market hypothesis (EMH) has been subject to professional and academic debate and analysis for many years, and refers to the theory proposing that stock prices show all information regarding a firm’s value. An efficient market is a market in which investors with the same information and similar investment goals compete actively (Sewell, 2012). Many private investors and investors aiming to make profits are involved with the stock market and often make low risk investments while aiming for high rates of return. However, the efficient market hypothesis states that it is impossible to consistently outperform the stock market as the market is able to quickly adjust to new information. The Efficient Market Hypothesis also addresses

Market efficiency requires that security prices react immediately in an unbiased way to the receipt of new information (Robert Shiller S1998). In other words, an efficient capital market is one in which stock prices fully reflect available information. In addition, there are three conditions for market efficiency; information flows freely, market is composed of rational investors where all competing against each other with the objective of maximizing wealth and there is no market imperfections. In efficient market, investors actively compete in the market based upon perceived mispricing derived from an analysis of

Even though the CAPM still is relevant, several empirical tests have figured out a flatter SML than expected as well as a contrary return-beta relationship. Researchers have tried to explain this anomaly. One is the betting against beta factor mentioned by Frazzini and Pedersen and should be discussed in this essay.

A trade-off often shows the link connecting risk and return. Presented the opportunity amid (Garnger, 2010) "two alternatives

The stock market is based on a never ending amount of factors, everything that seems to happen in the world good or bad always seems to have some sort of effect on the market and our economy. Ranging from new company startups, other

Fama (1970) stated that a stock market is considered efficiency when the security prices are fully incorporated and reflect the relevant and available information. However, how the market is evaluated as efficient as supposed? Indeed, the “efficient market” is called so when it will not enable investors to earn more than the average returns if they do not accept risks higher then average risk. Therefore, believing in Efficient Market Hypothesis Theory means that the attempt either to search for undervalued stocks or to predict and