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Capital Asset Pricing Model
(CAPM)
Assumptions of CAPM
1. All investors aim to maximize economic utilities.
2. All investors make decision based on the retur...
Assumptions of CAPM
9. There is no inflation in the market.
10.There is no tax payable for investors.
11. All investors ar...
Capital Market Equilibrium
Occurs when there is no more incentive for investors to trade.
Assumptions under capital market...
Market Portfolio
AB curve shows the market portfolio, combination
of risk and risk-free securities.
In equilibrium, all ri...
Capital Market Line
CML shows all the possible combination of
efficient portfolio, which consist of risk and
risk free sec...
Capital Market Line
Equation for Harga pasar dari resiko:
Securities Market Line
Depict tradeoff between risk and expected return for efficient portfolio, but not for individual se...
Securities Market Line
Beta for market portfolio is 1
Securities which have beta <1 considered
less risky than market port...
CAPM Formula
Elton and Gruber (1995) introduce Capital Asset Pricing Model (CAPM)
This formula can be used to calculate th...
CAPM Example
RFR = 9%;E(Rm) = 13%; βA = 1,3
E(RA) = 9% + (13% - 9%) . 1,3
= 9% + 5,2%
= 14,2%
To check whether the securit...
Example 2
IHSGt: 2.400; IHSGt-1: 2.000; RFR: 8%
RRM = (IHSGt-IHSGt-1)/IHSGt-1 RA= (1.350-1.000)/1.000 = 35%
= 2.400-2.000/...
Example 2(Cont.)
Real Return:
E(RA)= 8% + 0,8 (20%-8%)= 17,6%
E(RB)= 8% + 1,2 (20%-8%)= 22,4%
E(RC)= 8% + 1,5 (20%-8%)= 26...
CAPM Model Explained
Market Portfolio Risk
Contribution of each securities towards market portfolio risk is depends on the...
BETA CALCULATION
Beta is the covariance return of individual securities
CAPM Model Explained (cont.)
Market portfolio risk measured by standard deviation
Security risk contribution towards total...
Empirical Testing of CAPM
CAPM Model can be tested if the model has been converted into ex post model
Where:
Ri.t = Return...
The difference between Ex ante and Ex post
Ex Ante
Theoretical model
Slope of Securities Market Line (SML) should
be posit...
Empirical Testing of CAPM (cont.)
Predictions:
Intercept δ0 is expected not differ significantly to 0
Beta is the only fac...
Results of testing the CAPM model
The value of intercept is significantly higher than 0
The coefficient of beta has small ...
Capital Asset Pricing Model (CAPM)
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Capital Asset Pricing Model (CAPM)

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Capital Asset Pricing Model (CAPM)

  1. 1. Capital Asset Pricing Model (CAPM)
  2. 2. Assumptions of CAPM 1. All investors aim to maximize economic utilities. 2. All investors make decision based on the return and standard deviation. 3. All investors have Homogenous expectation towards input factors that is used to make portfolio. 4. All investors can lend and borrow unlimited amount under the risk free rate of return. 5. Short selling is allowed. 6. Securities as highly divisible. 7. All securities are liquid, can be sold at current market price. 8. No transaction fee.
  3. 3. Assumptions of CAPM 9. There is no inflation in the market. 10.There is no tax payable for investors. 11. All investors are price-takers 12. The capital market is in equilibrium.
  4. 4. Capital Market Equilibrium Occurs when there is no more incentive for investors to trade. Assumptions under capital market equilibrium: 1. All investors will choose market portfolio. 2. Market portfolio contained optimized securities, efficient frontier.
  5. 5. Market Portfolio AB curve shows the market portfolio, combination of risk and risk-free securities. In equilibrium, all risk securities should be at market portfolio (M), so the market portfolio is perfectly diversified. In practice market portfolio is only contained securities in one market (i.e. IDX), not all securities in the world.
  6. 6. Capital Market Line CML shows all the possible combination of efficient portfolio, which consist of risk and risk free securities. Premium risk shows the difference of expected portfolio with risk-free securities and market portfolio. The slope of CML is the market price of risk for efficient portfolios.
  7. 7. Capital Market Line Equation for Harga pasar dari resiko:
  8. 8. Securities Market Line Depict tradeoff between risk and expected return for efficient portfolio, but not for individual securities In portfolio, additional expected return happens because of additional risk from portfolio itself In individual securities, additional expected return is because of additional individual securities risk which is determined by Beta Beta determined the amount of additional expected return for individual securities with argument that for portfolio which is perfectly diversified, non systematic risk is gone This argument is based on the assumption homogenous expectation (every investor will create perfectly diversified portfolio. leaving only Beta risk)
  9. 9. Securities Market Line Beta for market portfolio is 1 Securities which have beta <1 considered less risky than market portfolio risk Securities which have beta >1 considered more risky than market portfolio risk Securities which have beta = 1 is expected to have same expected return of market portfolio expected return
  10. 10. CAPM Formula Elton and Gruber (1995) introduce Capital Asset Pricing Model (CAPM) This formula can be used to calculate the expected return from a portfolio or individual securities RBR = Risk Free Rate (RFR) βi = Beta E(Rm) = Market Portfolio Expected Return
  11. 11. CAPM Example RFR = 9%;E(Rm) = 13%; βA = 1,3 E(RA) = 9% + (13% - 9%) . 1,3 = 9% + 5,2% = 14,2% To check whether the securities are undervalued or overvalued is by comparing the expected return with the real return
  12. 12. Example 2 IHSGt: 2.400; IHSGt-1: 2.000; RFR: 8% RRM = (IHSGt-IHSGt-1)/IHSGt-1 RA= (1.350-1.000)/1.000 = 35% = 2.400-2.000/2.000 RB= (5.500-5.000)/5.000 = 10% = 20% RC= (1.400-1.000)/1.000 = 40% Securities A Securities B Securities C Price at t Rp. 1.350 Rp. 5.500 Rp. 1.400 Price at t-1 Rp. 1.000 Rp. 5.000 Rp. 1.000 Beta 0,8 1,2 1,5
  13. 13. Example 2(Cont.) Real Return: E(RA)= 8% + 0,8 (20%-8%)= 17,6% E(RB)= 8% + 1,2 (20%-8%)= 22,4% E(RC)= 8% + 1,5 (20%-8%)= 26,0% Conclusion: Securities A= Undervalued; Securities B= Overvalued; Securities C= Undervalued
  14. 14. CAPM Model Explained Market Portfolio Risk Contribution of each securities towards market portfolio risk is depends on the return covariance with the market portfolio
  15. 15. BETA CALCULATION Beta is the covariance return of individual securities
  16. 16. CAPM Model Explained (cont.) Market portfolio risk measured by standard deviation Security risk contribution towards total portfolio risk contribution can be considered as a change of portfolio risk due to changes in proportion of the securities
  17. 17. Empirical Testing of CAPM CAPM Model can be tested if the model has been converted into ex post model Where: Ri.t = Return on asset i in period t RBR.t = Risk Free Rate in period t βi = Beta Rm.t = Return on market portfolio in period t ei.t = Error
  18. 18. The difference between Ex ante and Ex post Ex Ante Theoretical model Slope of Securities Market Line (SML) should be positive Ex Post Empirical model Slope of Securities Market Line (SML) Should be 0 or negative E(RM) E(Ri) M RBR 0 1,0 Beta 1,0 Beta M RM 0 RBR Ri
  19. 19. Empirical Testing of CAPM (cont.) Predictions: Intercept δ0 is expected not differ significantly to 0 Beta is the only factor that explains return of security risk . Relationship between Return and Risk should be Linear δ1 should be positive or the return on market portfolio must be higher than Risk-free Rate of Return
  20. 20. Results of testing the CAPM model The value of intercept is significantly higher than 0 The coefficient of beta has small value than return on market portfolio minus Risk-free Rate of Return The coefficient of beta has positive value / δ1 > 0 Other factors (beside Beta) can explain the portion of securities return P/E ratio (Basu 1977) Firm-size (Banz 1981 and Reinganum 1981) Dividend yield (Rosenberg and Marathe 1977, Litzenberger and Ramaswamy,1979) Seasonality effect or January effect (Keim,1985)

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