Market Theory, Capital Asset Pricing Model

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.

B. can take on negative values C. is related to the covariance of a share D. All of the given answers. 11. Portfolio risk is heavily based on: A. a simple average of the variance of the stocks in the portfolio B. a weighted average of the variance of the stocks in the portfolio C. a weighted average of the covariance of the stocks in the portfolio D. the standard deviation of the stocks 12. When an investor alters the mix of their portfolio to reflect market changes, this is called _____ asset allocation A. market timing B. passive

The portfolio’s overall risk is minimised further through diversification within the portfolio’s assets. The method used in MPT, together with the major equations needed for MPT for financial assets (such as stocks), are outlined below.

1. If returns are normally distributed, expected return and standard deviation are the only two measures that an investor need consider.

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

It would be great to live in a world where investing provided guaranteed payout with little or no risk, however, we all realize that is not the way investing works. Generally, the greater the risk, the greater potential for return or worse, loss. How we perceive and respond to risk is a very personal decision and there are several factors that go into making that decision. In this paper, I will discuss the risk of stock investing. There are two types of risk involved in investing in stock. One is diversifiable risk and is completely controlled by the investor. It means that a portfolio should be filled with stocks of varying degrees of risk. The other type of risk is market risk. The

Part I. The company that I have chosen is Constant Contact. They trade on NASDAQ and their ticker symbol is CTCT. The company is a marketing firm, and according to Yahoo! Finance they are engaged in "on-demand email marketing, social media marketing, event marketing and online survey products, primarily in the United States." The beta for CTCT is 1.47. This beta indicates that the company is more volatile in its stock performance than the general market. The inclusion of this company in a portfolio will increase the volatility of the portfolio. This means that the potential return will be greater, but so will the potential loss.

The analysis of this paper will derive the validity of the Fama and French (FF) model and the efficiency of the Capital Asset Pricing Model (CAPM). The comparison of the Fama and French Model and CAPM (Sharpe, 1964 & Lintner, 1965) uses real time data of stock market to practise its efficacy. The implication of the function in realistic conditions would justify the utility of the CAPM theory. The theory suggests that the expected return demanded by investors on a risky asset depends on the risk-free rate of interest, the expected return on the market portfolio, the variance of the return on the market portfolio, and

A __portfolio__ is a collection of financial assets or investments such as stocks, bonds, and cash. Portfolios can be held by either an investor, hedge funds, or a type of financial institution. __Risk tolerance__ is simply the amount of risk you are able to handle as an investor. The associated risk tolerance with a portfolio usually determines its design. When designing a portfolio, investors will always want to maximize return and minimize risk. However, as you may have heard, the higher the risk tolerance the the higher the return. Investors should always go with a risk tolerance that they are comfortable with both mentally and financially.

As a consequence of the expectation for earning a return, a portfolio investment is made through the portfolio of the investment of securities. However, the investment's expected risk is always significantly related to the expect return in portfolio construction. Compared to direct investment, Portfolio investment is distinct in which a sizable target companies’stake will be managed day by day.

As Clark and Kim (2013) said, portfolios are the objects of choice. A great amount of information is needed for investors to make a decision because it is smarter to divide the money in different assets instead of concentrating on a specific financial product. Portfolio analysis was created by the Nobel laureate Harry Markowitz

Lastly there is you our personal risk tolerance, this is perhaps plays one of the most important factor in determining the allocation of portfolio funds. Risk tolerance simply put is your ability and willingness to lose either a portion or in some cases all of your original investment for a possibility of a greater return. An investor with a high-risk tolerance or one that is more inclined to put their money on the line in over get a more profitable return

Graham and Harvey (2001) surveyed the CFOs of 392 U.S. firms and found that when estimating the capital of assets,73.5% of respondents use CAPM. It is a model which use simple formula to evaluate asset pricing and investor behavior. This model is absolutely the method with most investors used but many financial experts raise an objection to the veracity of this method in the recent years. Later in the main body of essay will discuss these question; In the first part of the essay will introduce the CAPM and the main factor of this method. Secondly is the discussion of the uses and limitation of the CAPM while evaluating the potential investment of a firm 's share. After that is the adverse and favorable way of CAPM as a resource of discount rate. The last paragraph is the conclusion that rating the merits and demerits of the CAPM in the investment.

The modern portfolio theory posits that an investor should be rewarded for taking on risk by receiving an appropriate amount of extra return and concomitantly. This means higher returns normally carry greater risks.

Capital market is most important sectors where we invest our money. Business students of course want to invest in share-market because s/he knows well about share-market. So this research topic is related with students’ future career.