The Theory Of Capital Asset Pricing Model

The Theory of Capital Asset Pricing Model
Running Head: Capital Asset Pricing Model
Capital Asset Pricing Model
Introduction
This research paper tends to describe the theory of Capital Asset Pricing Model, which is a
theoretical invention much useful for businesspersons and investors who invest with the prevailing
risk in the economical environment. The key points of the theory are extracted and highlighted with
respect to the explanation of William Sharpe's "A theory of Market Equilibrium under conditions of
risk".
Capital asset pricing model is a model, which was introduced in order to understand the relationship
between the risk and the investment that is made. What businesspersons or investors tends to do is
make return of their investment fairly equally with return of the risk that has been taken on their
part. They want to be compensated for the risk they have taken with their investment. At this point,
the time value of money is of great importance since it describes what the investment's value will be
after the prescribed years from now (Korajczyk, 1999). This model explains how much of the return
will be received by taking the risk and what are the chances that the return on investment
compensates. Though its tests are difficult to be employed, results may differ or sometimes may
come out as wrong assumptions and calculations. Every investment induces risk when it takes place
and if the resulting conclusions propose that the return on investment and risk will not be made as
desired then the investment
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Advantages Of Capital Asset Pricing Model
Capital Asset Pricing Model (CAPM) Capital Asset Pricing Model(CAPM) is introduced by Sharpe,
Lintner, and Mossin and this model is derived by Markowitz mean–variance model theory. CAPM is
applied to investment decision problems. CAPM is also about the understanding of an assets return
and also the diversify of risk. The formula of CAPM is derived in that forms:– There are two ways
of CAPM can be compensated that are time value of money and risk. The risk–free(rf) rate is
represent the time value of money in the formula and compensated the investors where placing their
money in any investment over a period of time. The yield of government bonds like Malaysia
Treasuries is an example of risk–free rate. Risk are represented by the other half of the CAPM
formula and it is calculates the amount of compensation the investor needs for taking on extra risk.
Beta is a risk measure which it is calculated that compare the return of an asset to the market over a
period of time and to the market premium(rm–rf). This tell that the return of the market in excess of
the risk–free rate. The risk of an asset is reflected by the beta is compared to overall market risk and
also as function of the volatility of the asset and the market correlation between the two. ... Show
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This theory is proposed by Stephen Ross in the years 1976 and this theory is based on an assets
returns or assets portfolio where the relation of an asset and common risk factors is clearly
predicted.. The sensitivity of each factor would changes is represented by a factor specific beta
coefficient. This theory also discuss about the price of an expected assets will be predicted whether
it is mispriced or not. The formula of APT are about the expected return on a stock or other security
and it is calculated as shown below:– Expected return = r(f) + b(1) x rp(1) + b(2) x rp(2) + ... + b(n)
x rp(n) r(f) = the risk–free interest

Capital Asset Pricing Model ( Capm )
INTRODUCTION
Firm has a range of projects to be invested in or finance in to increase the value of the company.
However, to increase the value of the company, firm need to choose the worth pursuing project. In
this case, firm need to evaluate the projects which the evaluation of a project can be done by cash
flow method.
The paper depicts how weight average of cost capital is used as a source of a discount rates for
capital budgeting. In this paper, the discount rate in the weight average of cost capital (WACC) will
be used in the net present formula. To calculate the WACC, most company use the after tax WACC
as the formula is much closer the reality events. Then, the paper will discuss which formula that will
be applied on the project ... Show more content on Helpwriting.net ...
As can be seen on the formula the weight of the cost capital includes debt and equity market value,
cost of debt and equity, and the deduction of the corporate tax. The weight of average cost of capital
formula:
source: Kaplan Financial Knowledge Bank
Figure 1
Regarding to the figure 1, the figure depicts the relationship between cost of equity, cost of debt
times(1–t) and the cost of WACC with the value of company. The is the rate of return on levered
equity, is the interest rate that been charge for debt, the weight average cost of capital decrease, this
is because the occurrence of the corporate tax, reduce the tax payment which decrease the interest
rates of the borrowing. The value of company (D+E) is increase due to increase in cost of equity
which the (Mitra,2011). The traditional formula of Weight average cost of capital (WACC) by the
Modigliani and Miller is simple to use and it is close to the reality. The projects or investment that
been evaluated need to have same risk and same capital structure in terms of using the weight
average cost of capital formula. Furthermore, the simplicity of the traditional formula is because the
using of only one single discount rate. However, different projects with different risk of the debt
capacity require different discount rate for project evaluation. The alternative of Modigliani and
Miller formula for the difference in project debt level is

Market Theory, Capital Asset Pricing Model
Capital market has deep developed this century, more and more investors go into this market. Which
security is better? How to invest? Investors need numeric index to make decision. There are some
theories to help investors: portfolio theory, capital asset pricing model (CAPM), option pricing
model and so on. This essay will explain portfolio theory firstly. Secondly, this essay will explain
CAPM and discuss the importance of the assumptions of CAPM. Thirdly, this essay will explain
arbitrage pricing theory (APT) and factors model. Finally, this essay will compare CAPM with APT
and factors model. Harry Markowitz put forward portfolio theory in 1952; portfolio theory is that
using portfolio diversification to eliminate non–systematic risk; portfolio theory uses mathematical
methods σanalysis the relationship between risk (variance) and expect return (mean) (Brealey,
Myers and Allen,2014). Mean–variance criterion is very important for Portfolio theory. The mean is
the expect return of portfolio, the formula of expect return for one asset is: E (r) = ∑_(all states)▒
〖r×y(states)〗 r is return; y is the probability of return. Formula of expect return for portfolio is:
E(r) =w_1*E (r_1) + w_2*E (r_2) + ... + w_n*E (r_n) w is the weight of an asset in the portfolio.
The variance represents risk of portfolio, and the formula of portfolio's variance is: σ^2=E [〖(r–
¯r)〗^2] = ∑_(i,j=1)^n▒〖w_1 w_2 Cov(r_1,r_2)〗 Cov is the covariance. If there are just two
assets, this

Critically discuss the uses and limitations of the CAPM
Introduction
Capital Asset Pricing Model (CAPM) was developed in 1964 based on Modern Portfolio Theory.
CAMP widely used in investment decisions and financial areas of the company. The main research
of CAMP are the relationship between expected rate of return and risk assets in the stock market, as
well as how the equilibrium price formation. In terms of the valuation of assets, CAPM primarily
used to determine whether the securities market be mispricing. Capital Asset Pricing Model measure
risk by non–diversified variance, it linked risk and expected return, any non–diversified risk assets
can be described by the value of β, then calculate the expected rate of return. Rate of return required
by investors is equals to the discount rate. The limitation of CAPM are: CAPM assumptions
inconsistent with the actual; CAPM Should apply only to capital assets, human assets may not be
traded; Estimated β coefficient represents the past of variation, but investors are concerned about the
security volatility of future price; In the actual situation, the risk–free asset and the market portfolio
may not exist.
Main Body
The advantage of CAPM is that it provide a clear and intuitively explicit forecast in regard to how to
measure risk and the connection between risk and expected return(Fama & French ,
2004).Accordance to the provisions of CAPM, Beta coefficient is used to measure an asset systemic
risk, it is used to measure the

Concept Of Capital Asset Pricing Model
1. Introduction
Capital asset pricing model know as CAPM is a model for calculates the required rate of return for
any risky asset. This method is often used to determine the fair price of an investment should be.
This essay will discuss about usage of CAPM in securities industry, through probe the advantages
and limitation of CAPM to this industry.
2. Concept of Capital asset pricing model
During 1952, Markowitz came out with a theory based on diversified investment is able to construct
the risk–averse investors. He diversified investment portfolio theory and efficiency of the priory
rigorous mathematical tools as a means to demonstrate risk–averse investors in a number of risky
assets in construct the optimal portfolio methods (Markowitz, 1952).
But due to the existence of some problem, from the early 1960s began, some economists began to
representatives from the empirical perspective, and explore investment securities reality that
Markowitz's theory in reality can be simplified? By building on the theory of Harry Markowitz on
diversification and modern portfolio theory, William F.Sharpe (Sharpe, 1964), John Lintner (Lintner,
1965) and Jan Mossin (Mossin, 1966) had come out with the new theory which is knows as Capital
asset pricing model.
As expected based on the risk assets of the prediction model based on equilibrium income, CAPM
describes the formation of market equilibrium at investors using Markowitz's theory of investment
management conditions, the expected

Critical Analysis of the Relative Merits of the Capital...
Critical Analysis of the Relative Merits of the Capital Asset Pricing Model (CAPM) and the Fama
and French (F&F) Three–Factor Model (TFM)
Introduction
During the 20th century, securities trading in the stock market has significantly increased. Since
then, many studies have analysed the performance of managed portfolios and evaluated the way
investors explain returns on stocks (Jagannathan and Wang, 1996). The most common theory used
by managers and practitioners is known as the Capital Asset Pricing Model (CAPM). However, this
theory has been criticised by some empirical models. This paper will critically analyse the relative
merits of the CAPM and will discuss the Fama and French (F&F) three–factor model (TFM) as
one possible ... Show more content on Helpwriting.net ...
The author mixed the DER with the CAPM and stated that the coefficient of DER was substantial
and 0.13% per month.
2. The Three–Factor Model (TFM) Most critics of the CAPM suggest the empirical models, such as
APT, TFM, etc., as alternative approaches to the CAPM. This paper will focus on the TFM, because
it is usually the model researchers test and use.
F&F (1992) has investigated the association between CS stock returns and the five common
suggested factors (the beta, the size of the firm, the BTMR, the EPR, and the DER) on the U.S.
Stock Market. According to F&F, the impacts of the DER and the EPR can be absorbed by the
BTMR and the size of firm factors. In preparation for examining the strength of the size of the firm
and the BTMR impacts, they separated the examination period into three sub–periods. The authors
discovered that the market beta was affirmative only during a single period. However, it could not
be statistically substantial. The impact of the firm's size was insignificant, from 1977 to 1990, but it
was substantially associated to stock returns.
On the other hand, the BTMR was substantial and affirmatively associated with stock returns for the
three periods of the examination. According to that study's findings, the beta factor was not a
substantial variable in explicating the stock returns. The authors added that the factors of the firm
size and the BTMR are precisely enough to explicate

Capital Asset Pricing Model : William Forsyth Sharpe Essay
Youssef El Hennawy
Mr. John Kennet
Grade 10 Yellow
13 May, 2016
One the creators was William Forsyth Sharpe born June 16, 1934 (age 81) Boston, Massachusetts,
U.S is an American economist. He graduated from Riverside Polytechnic High. He is the STANCO
25, he was a professor of Finance, Emeritus at Stanford University 's Graduate school of Business,
and the winner of the 1990 Nobel Memorial Prize in Economic Sciences. Sharpe was one of the
originators of the capital asset pricing model. He created the Sharpe ratio for risk–adjusted
investment performance analysis, and he contributed to the development of the binomial method for
the valuation of options, the gradient method for asset allocation optimization, and returns based
style analysis for evaluating the style and performance of investment funds.The second creator was
Jack Lawrence Treynor was born on February 21 1930 and passed away in May 11, 2016. He was
the President of Treynor Capital Management, Palos Verdes Estates, CA. He was a Senior Editor
and Advisory Board member of the Journal of Investment Management, he was also a Senior Fellow
of the Institute for Quantitative Research in Finance. He was also a editor of the CFA Institute 's
Financial Analysts Journal.John Virgil Lintner, Jr. (February 9, 1916 – June 8, 1983) was a professor
at the Havard Business school in the 1960s and one of the co–creators (1965a,b) of the capital asset
pricing model.
For a time, much confusion was

The Cost Of Equity And Capital Asset Pricing Model
1.0 Introduction
The cost of equity refers to the minimum rate of return which a company must offer investors
compensation in exchange for bearing risk and waiting for their returns (Pike et al., 2012). The
return consists of two elements, the prospective dividend yield and the expected rate of growth in
dividend (Pike et al., 2012). There are two ways to calculate the cost of equity which are Dividend
Growth Model and Capital Asset Pricing Model (CAPM).
Dividend Growth Model is a valuation method which takes into consideration dividend per share
and its expected growth. This model assumes that dividends will be constant or growing at a fixed
rate in perpetuity.
On the other hand, Capital Asset Pricing Model explains how individual securities are valued, or
priced, in efficient capital markets (Pike et al., 2012). This involves discounting the future expected
returns from holding a security at a rate that adequately reflects the degree of risk incurred in
holding the security. CAPM shows that only risk premium will be related to systematic or non–
diversifiable risk.
This paper will first look at Dividend Growth Model and Capital Asset Pricing Model theory, then
discussing the advantages and disadvantages when apply each of the model. The purpose of this
paper is to evaluate each method and examine which is the most suitable method to calculate the
cost of equity finance.
.
2.0 Discussion
The theory and formulae of Dividend Growth and CAPM will be discussed in this

Notes On Capital Asset Pricing Model
2. Review Of Previous Empirical Findings
In 1959, Markowitz laid a portfolio theory where he introduced mean–variance efficient portfolio
that explained minimum variance for given expected return and maximum return for given variance.
This revolutionized the finance field and provided groundwork for Capital Asset Pricing Model
(CAPM) founded by William F. Sharpe (1964) and John Lintner (1965). Sharpe and Lintner showed
that when investors hold mean–variance efficient portfolio and expect homogeneously, then even in
absence of market fluctuations the portfolio formed would itself be mean–variance efficient
portfolio.
Sharpe and Lintner added two assumptions namely, complete agreement and borrowing and lending
at risk–free rate to the ... Show more content on Helpwriting.net ...
All idiosyncratic or nonsystematic risks of the market are eliminated. Only non–specific risk (β)
explains the sensitivity of the expected rate of return on security with change in market portfolio.
Beta is the ratio of covariance of excess return on security and excess return on market portfolio and
variance of excess marker return. (Dzaja and Aljinovic, 2013)
The standard CAPM model is applicable only when the above assumptions are met. Thus, investors
are concerned about only mean–variance of the stock returns. The traditional CAPM (single–factor
model) is relied on the normality of returns and quadratic utility function. It is also known as two–
moment model. In 1969, Douglas investigated the standard CAPM and found the discrepancies in
the actual relationship of CAPM from the capital market. He found that the intercept term
(minimum rate of return on portfolio) and the risk–free rate were not equal as anticipated by Sharpe
and

This essay will illustrate the practicability of the capital asset pricing model (the CAPM). Before 30
years ago, the capital asset pricing model was a significant development. This theoretical model has
been used in many large companies. Yet, many economists argue that this model has its own
drawbacks. In 1992, Fama and French said that the application of CAPM could be useless which
against empirical tests of the CAPM. For instance, the CAPM was seen as an obsolete theory
because of the limitation of its assumptions. Main assumptions can be categorized into six aspects.
First, the CAPM assumption was built on that the capital market is always in equilibrium. This
assumption is difficult to achieve in the real world. Second, there are a numeral of investors who
hold the same period of their asset in the market and no considering of the outcome after the
investment plan. However, there are too many investors in the market, it is impossible that their time
of holding the asset could be exactly the same. Therefore, the second assumption is also
unachievable. The third hypothesis is that investors have unrestricted of borrowing and lending at
fixed risk–free rate which is also very difficult. The fourth of assumption is assumed that there are
no transaction costs and taxes. But in fact, these factors are all existed in the real market. Then, the
fifth and sixth assumption shows all investors have the same expectation on their investment
portfolio. Obviously, these two

Ever wonder if generating alpha is a zero–sum game or if quotes like the below hold:
"Active management can generate alpha for investors and passive investing cannot"
"In a market with low returns active management is better, as alpha becomes more important"
In this post we will establish how much alpha is available in the market, and why statements like the
above are simply ridiculous.
To begin, let 's define alpha? Investopedia defines it in the below ways:
A measure of performance on a risk–adjusted basis. The abnormal rate of return on a security or
portfolio in excess of what would be predicted by an equilibrium model like the capital asset pricing
model (CAPM). ... Show more content on Helpwriting.net ...
Worst, are they intentionally confusing the public? I believe it 's the former but let's elaborate why
those claims are false.
Fed Policy and Active vs. Passive Performance
The Fed policy plays no role in whether active or passive management will outperform. It's the case
because as we established here "Passive vs. active", all passive index funds do is copy the active
managers. As a quick refresher, the active management community purchases and sells securities on
perceived mispricings. By doing this, they establish the values of all the public companies. Passive
funds purchase those same securities in the exact same relative weights the active managers have
assigned them. Of course, unless not truly passive. For instance, any portfolio that is not value–
weighted is active (equal–weighted index is an active portfolio, its bullish small caps). For example,
if all active managers combined have assigned 1/10 of their assets to company X, the passive fund
will assign 1/10 of its portfolio to company X. If company X produces 10% return throughout the
year, both passive and active managers will get the same proportionate return. That is why before
fees active and passive managers

The Capital Asset Pricing Model
From the very time of its development, there have been many attempts to prove the validity of the
Capital Asset Pricing Model. For instance, Black, Jensen and Scholes (1972) performed a test to
check if securities are priced accordingly to their systematic risk. In order to test the theory that
there was a positive linear relation between the expected return and beta, instead of the individual
stock, they used monthly return data and portfolios. They obtained ten portfolios of monthly returns
for 35 years and ranked them by risk securities, from the highest to the lowest. This sorting
technique is now regularly used in empirical checks. They discovered that the intercepts α were
regularly negative for the high–risk portfolios and always ... Show more content on Helpwriting.net
...
He formulated an opinion that such proxy, when used to calculate return on the market, cannot
guarantee to be mean–variance efficient.
The evidence gained from examination done by Nimal and Fernando (2013) concerning Tokyo
Stock Exchange (TSE) and the Colombo Stock Exchange (CSE) confirmed not only that beta is a
useful tool in expanding deviations in market premium, but also that there is a relation between
return and beta. However, the previous research done in the Japanese market by Yonezawa and Hin,
(1992) did not confirm the validity of the CAPM. In their research, they checked monthly returns
from January 1952 to December 1986 and concluded that limited diversification was the main cause
of CAPM failure.
Pettengill et al. (1995) suggested a new method for testing the relation between return and beta.
They established a conditional model which anticipates whether the risk premium on the market
index is positive or negative. When the excess return on the market index is positive there should
also be a positive relationship between beta and return, and when the risk premium is negative and
return also negatively connected. It is based on a fact that high beta stocks are very likely to be more
sensitive to the negative risk premium and even have a lower return than low beta stocks. Their
research conducted on the US market confirmed that there is a positive relation between betas and
returns.
The same conclusions were

Introduction
This essay is mainly focused on Capital Asset Pricing Model (CAPM) and how beta (measure of
volatility) influences investment decisions. Nevertheless, how much we diversify our investments, it
's impossible to get rid of all the risk. As investors, we deserve a rate of return that compensates us
for taking on risk. The capital asset pricing model (CAPM) helps to compute the investment risk and
expected returns. Throughout in depth analysis of CAPM model discussed in this essay, we will be
looking how beta influences investment decisions and what are the risk associated with different
industries. Moreover, how to minimise risk and what are different types of risks involved when
investing in different portfolios. This essay is written to critique the ability of a portfolio investment
combatting risk as a whole.
Capital asset pricing model was developed by Sharpe (1964) and furthered through the works of
Lintner (1965), Mossin (1966), Treynor (1965) and Black (1972). This model calculates
expected/required rate of return for any risky financial asset. Capital Asset Pricing Model formula is
shown in figure 1.1. Essentially, this represents investors need to be compensated for their time
value of money and risk. Beta is measure of volatility and will be further examined in later stages of
this essay. For example, if our particular company has a high standard deviation of the rate of return,
an investment in the company might appear

Capital Asset Pricing Model (Capm)
Introduction Capital asset pricing has always been an active area in the finance literature. Capital
Asset Pricing Model (CAPM) is one of the economic models used to determine the market price for
risk and the appropriate measure of risk for a single asset. The CAPM shows that the equilibrium
rates of return on all risky assets are function of their covariance with the market portfolio. This
theory helps us understand why expected returns change through time. Furthermore, this model is
developed in a hypothetical world with many assumptions. The Sharp–Lintner–Black CAPM states
that the expected return of any capital asset is proportional to its systematic risk measured by the
beta. (Iqbal and Brooks, 2007). Based on some simplifying ... Show more content on
Helpwriting.net ...
The equation for the SML calculates the return on an investment given its risk. The graph
illustrating this line represent a quantitative relationship between risk and return because the
measure of risk in a well–diversified portfolio is the contribution of an asset to the portfolio's
variance, as measured by beta. Thus, the SML serves as a benchmark for assessing the performance
of an individual asset or the assets of an entire portfolio. Results KLSE INDEX |Companies
|Standard Deviation |Beta |Required Return | |AEON |11.83% |1.03 |6.97% | |DIALOG |15.76% |2.44
|16.52% | |AMWAY |2.23% |0.13 |0.88% | |BINTULU |5.28% |0.69 |4.67% | |KFC |6.28% |0.51
|3.45% | |BERJAYA |23.02% |2.08 |14.08% | |HAP

Critically discuss the uses and limitations of the CAPM
Introduction
Capital Asset Pricing Model (CAPM) was developed in 1964 based on Modern Portfolio Theory.
CAMP widely used in investment decisions and financial areas of the company. The main research
of CAMP are the relationship between expected rate of return and risk assets in the stock market, as
well as how the equilibrium price formation. In terms of the valuation of assets, CAPM primarily
used to determine whether the securities market be mispricing. Capital Asset Pricing Model measure
risk by non–diversified variance, it linked risk and expected return, any non–diversified risk assets
can be described by the value of β, then calculate the expected rate of return. Rate of return ... Show
Since Asset Evaluation discount rate is determined by return on capital employed (or ROI)
assessment project, Therefore, the capital asset pricing model has a wide range of application in
assessment. The central role of CAPM method is to analyze the portfolio and securities value, then
find the cheap securities. It provides a standard for evaluate the value of securities. Expected rate of
return of each security shall be equal to the risk–free rate plus a risk premium measured by the
coefficient β: Ri= Rf+ βi( Rm– Rf). When the expected of return of the market portfolio is estimated
and the β of the securities is estimated, then the expected of return under the market equilibrium can
be calculated. In addition, there is an expected value in market arising from the future income(
dividends and terminal value). Ri= ( dividends + terminal value)/ initial value – 1. In an equilibrium
state, these two expected rate of return should be the equal, and the initial value should be set at
(dividends + terminal value ) /(Ri + 1)(Da & Jagannathan, 2012). Compare the current actual market
price with the equilibrium of the initial price. If they are not equal,it is indicated that the market
price is set by mistake. The mistake price should have the return requirement, it can obtain excess
returns by using this(Da & Jagannathan, 2012). Specifically, when the actual price is lower than the
equilibrium price, indicating that the stock is cheap

Capm: Capital Asset Pricing Model
Introduction
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.
Basic summary of the CAPM theory
CAPM is Capital Asset Pricing Model. The CAPM formula shows a linear relationship between the
expected return and systematic risk (Brealey, Myers and Allen, 2011). The formula is:
E (Ri) = rf + βi [E (Rm) – rf]
In this

What Are The Pros And Cons Of The Capital Asset Pricing Model
1. Executive Summary
In this essay, we will discuss the Capital Asset Pricing Model (CAPM) and its role in the business
world. We will analyze the pros and cons of the CAPM Model, and how it is being used not only in
the education level and also in the current business markets. We will discuss the initial purpose of
CAPM, and identify its criticisms. After identifying their weaknesses, we will analyze whether there
were any improvements made to CAPM. Furthermore, we will discuss why the improvements were
made, and whether the improved CAPM were successful in combating the criticisms.
2. Introduction of Capital Asset Pricing Model (CAPM)
According to Brealey, Myers and Marcus (2012), CAPM states that the expected rate of return
demanded by investors ... Show more content on Helpwriting.net ...
Furthermore, the CAPM is only a single–period model. Critics mention that estimates for the risk–
free rate, market return and beta factor, are difficult to accurately determine in real–life. The
assumption that diversifiable risk is not taken in consideration does not work well for investors that
do not have a well–diversified portfolio. CAPM therefore overlooks unsystematic risk, which may
be of importance to investors who do not have a diversified portfolio. The CAPM's validity is due to
difficulties in applying valid tests of the model. CAPM states that "the risk of a stock should be
measured relative to a comprehensive "market portfolio" that in principle can include not just traded
financial assets, but also consumer durables, real estate and human capital" (Hill, 2014). Even
though CAPM is widely used in the corporate world, according to Fama and French (2004), CAPM
has never been an empirical success (p.43). Researchers found variables like size, various price
ratios and momentum that affects the average returns provided by beta (Fame and French, 2004,
p.43). The issues addressed in the studies were serious enough to invalidate most applications of the
CAPM (Fama and French, 2004, p.43). According to Wu (2007), the only economic prediction of
CAPM is that the market portfolio is mean–variance efficient. In study cited by Wu (2007), Roll
argues that a "true market portfolio should include all

Similarities And Differences Between The Single Index...
Outline the similarities and differences between the Single Index Model (SIM) and the Capital Asset
Pricing Model (CAPM). Justify which of the two models makes a better assessment of return of a
security (25 marks).
To reduce a firm's specific risk or residual risk a portfolio should have negative covariance or rather
it should have no variance at all, for large portfolios however calculating variance requires greater
and sophisticated computing power. As such, Index models greatly decrease the computations
needed to calculate the optimum portfolio. The use of such Index models also eliminates illogical or
rather absurd results. The Single Index model (SIM) and the Capital Asset Pricing Model (CAPM)
are such models used to calculate the optimum portfolio.
Sharpe (1963) defined SIM as an asset pricing model which is purely arithmetical. The returns on a
security can be represented as a linear relationship with any economic variable relevant to the
security, for example in stocks the single factor is the market return. According to Sharpe the Single
index model for return on stocks is shown by the formulae shown below;
Rs–Rf = α + β (Rm– Rf) +ε. α or alpha represents abnormal returns for stock.
Β (Rm − Rf) represents the markets movement. ε represents the unsystematic risk of the security.
The equation above shows the ... Show more content on Helpwriting.net ...
CAPM on the other hand is based on microeconomic ideas such as concave utilities and costless
diversification. Macroeconomic events mentioned include interest rates or the cost of labor, causes
the systematic risk that affects the returns of all stocks. On the other hand the firm–specific events
are the unexpected microeconomic events that affect the returns of specific firms for example the
death of key people that would affects the firm, but would have a insignificant effect on the

Portfolio Theory and the Capital Asset Pricing Model...
'Portfolio theory and the capital asset pricing model (CAPM) are essential tools for portfolio
managers and other stock market investors' In order to be successful, an investor must understand
and be comfortable with taking risks. Creating wealth is the object of making investments, and risk
is the energy that in the long run drives investment returns. PORTFOLIO THEORY Modern
portfolio theory has one, and really only one, central theme: "In constructing their portfolios
investors need to look at the expected return of each investment in relation to the impact that it has
on the risk of the overall portfolio". The practical message of portfolio theory is that sizing an
investment is best understood as an exercise in balancing its expected ... Show more content on
Helpwriting.net ...
If you had invested all of you're the whole £200 in the alpine resort, you would have made £420. if
you had invested the whole £200 in the beach club, you would have lost £120 of your capital,
leaving you with only £80 to re–invest–it would take time to get your money back to its original
level, and if you attempted to do so by investing again in only one of the two resorts, you might well
make a further substantial loss. Thus, the argument for spreading the risk is very strong. The two
resorts have negative covariance. Here is the formula for calculating covariance: Lets Ag and Ab be
the actual return from alpine resort in good and bad weather respectively, and A be the expected
return (average), Bg and Bb be the actual return from the beach club and B the expected return: The
covariance between A and B = COVAB = Probability of good weather (Àg – À)(ßg – ß) +
probability of bad weather (Ab– À)(Bb–ß) In my example, the probability of good or bad weather
are both 0.5, so: COVAB = [0.5(–30–15)(60–15)] + [0.5(60 – 15)(–30–15)] =0.5(–45 * 45) + 0.5(45
* –45) =–0.10125 + – 0.10125 = –0.2025 In real life, however, stocks

Capital Asset Pricing Model Applied to Constant Contact
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. Part II. For this exercise, it is assumed that the
present yield to maturity of US government bonds is 4.5% (it is actually much lower). The market
risk premium is assumed to be 6.5%. Using the capital asset pricing model, we can estimate the cost
of equity for Constant Contact. The capital asset pricing model is a method of determining the value
of a company based on current market characteristics and the historic performance of the company
versus the broad market. The capital asset pricing model can be used to calculate the firm's cost of
capital, or at least the firm's cost of equity. The cost of equity reflects the firm's cost of using equity
capital to finance its operations. The use of CAPM is effective, because the beta is based on market
performance of the company's stock. The market is assumed to be capable of making an accurate

Capital Asset Pricing Model (Capm) Versus the Discounted...
Capital Asset Pricing Model (CAPM) Versus the Discounted Cash Flows Method
Managerial Analysis/BUSN 602
Capital asset pricing model or CAPM is a financial model that measures the risk premium inherent
in equity investments like common stocks while Discounted Cash Flow or DCF compares the cost
of an investment with the present value of future cash flows generated by the investment with the
mindset being that if the cash flow is positive, then the investment is good. Generally speaking,
CAPM is a model that describes the relationship between risk and expected return and DCF is a
valuation method used to estimate the attractiveness of an investment opportunity. So what are the
differences, advantages and disadvantages of each one? How ... Show more content on
Helpwriting.net ...
It is focused on cash flow rather than accounting practices and allows for different components of a
company to be valued separately. Conversely, the biggest challenge of the DCF method is that the
determined value is only as accurate as the information it is given, that being the FCF, TV and
discount rates. In other words, if the information given to determine the DCF isn't accurate then the
fair value for the investment won't be accurate and the model won't be helpful when assessing stock
prices due to the inaccuracies. Furthermore, DCF is only good for long term values not short term
investing. "The bottom line is that DCF is a rigorous valuation approach that can focus your mind
on the right issues, help you see the risk and help you separate winning stocks from losers and help
reduce uncertainty." (McClure, 2011) So, now that we've looked at CAPM and DCF, what can we
conclude?
The CAPM is a single factor model because it based on the hypothesis that required rate of return
can be predicted using one factor that being systematic risk. It looks at risk and rates of returns,
compares then to the stock market providing a usable measure of risk to help investors determine
what return they will get for risking their money in an investment. There are a lot of assumptions
and drawbacks of CAPM that lead to the conclusion that those investors utilizing this

In the following essay I will be comparing and contrasting the effectives of the capital asset pricing
model (CAPM), Arbitrage Pricing Theory, and the Fama–French three factor model when estimating
the cost of capital and explaining performance of investment portfolios.
The CAPM model was developed by Sharpe (1964) to explain how capital markets set share prices.
(Pike and Neale) In result of research by Sharpe (1964), Litner (1965) and Black (1972) the Capital
Asset Pricing Model (CAPM) states "the relationship between beta (measure of volatility on
portfolios/assets) and expected returns is linear, exact, and has a slope equal to the expectation of the
market portfolio excess return". CAPM makes the assumption that markets are efficient therefore
suggesting that operators within the market have rational expectations, this assumption leads us to
the first weakness of CAPM (Vernimmen, 2011). However, when estimating the cost of capital,
CAPM is seen to be preferred compared to other asset pricing models simply due to its simplicity. In
a survey conducted by the Association for Financial Professionals (2011) it was found that when
estimating the cost of capital 87% of all firms and 91% of publicly traded firms used CAPM.
Guermat (2014) states that the results of CAPM are always correct in a technical sense however,
whether it is accurate to reality is questionable. I argue that we can only achieve an effective result if
variables such as beta and expected returns are

Capital Asset Pricing Model ( Capm ) And How It Can Be...
This paper looks at The Capital Asset Pricing Model (CAPM) and how it can be used by fund
managers when making investment decisions and the interaction of CAPM when calculating Alpha
which enables investors to assess the fund manager's performance. I will outline the principles of the
two measures including any limitations that they present along with my conclusion. Part 1 – CAPM
CAPM is considered to be an important device in financial management having been developed by
three academics, Sharpe, Lintner and Mossin during 1964 – 1966 (1). William Sharpe actually
published CAPM which was an extension of previous work conducted by Markowitz's portfolio
theory where he introduced the idea of systematic and unsystematic risk (2). The ... Show more
content on Helpwriting.net ...
The CAPM formula is of follows (4). E (ri) = Rf + Bi (E (rm) – Rf) E (ri) = return required on
financial asset i Rf = risk–free rate of return Bi = beta value for financial asset i E (rm) = average
return on the capital market So, E (ri) is the cost of equity and the premium an investor should
expect for taking on the additional risk and CAPM is based on a set of assumptions, including (5) :
All investors are rational and risk adverse All investors have an identical holding period No one
individual can affect the market price No taxes or transaction costs are taken into consideration
Unlimited borrowing and lending of risk free money It wasn't until after the bear market (this is a
declining market and it tends to begin with a sharp drop in stock prices across the board) of 1973 –
1974 that CAPM was really accepted and adopted by the world of finance lead by Wall Street (6).
During the period of January 1973 to December 1974, the stock market (DJIA) reduced in value by
46%, a steep increase in unemployment and a high rate of inflation around 11% in the US (7). Even
the UK suffered with strikes and an eventual change in government. Empirical evidence in the early
years of CAPM provided support especially with Sharpe and Copper (1972). (8) During their
testing, they used all stocks in New York stock exchange over a period between 1926 – 1968. Their
research found past Beta could be used for future

It could be definitely true that most of the investors who live in the highly competitive world of
finance want to make more profit on their stocks, bonds and securities and increase their income by
buying and selling those financial assets in today's financial market place. In other words, every
rational investor will try to increase and maximize his or her financial benefits and returns on capital
investment. Moreover, in a study Elton et al. (2004) state that the model of classical financial theory
presumes the fact that investors who work in a competitive market come to a rational decision.
However, the major problem might be to determine the value of those financial instruments.
A review of CAPM
According to Brealey et al. (2001) the capital asset pricing model (CAPM) is the theory based on
correlation among risk and return which indicates that asset 's beta multiplied by risk premium of
market will show the expected risk premium on the market portfolio. Similarly, Megginson et al.
(2007) confirm that the major idea of the capital asset pricing model (CAPM) is to point out that
required return of the security is risk free rate plus risk premium. Thus, investors demand expected
return on their investments based on the risk and return relationship of assets (Brealey et al., 2001).
Moreover, according to Megginson et al. (2007) the mathematical formula for determining the
expected rate of return on long–term asset is as follows:
E(Ri) = Rf + β[E(Rm) – Rf] where,
Rf –

The Capital Asset Pricing Model (CAPM)
5.2.4.6.1. The Capital Asset Pricing Model (CAPM)
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:
E(R i) = R f + β i [ E(R m) – R f] (1) where E(R i) is the expected return of the asset in question; Rf
is the risk free rate of return; E(R m) is the market expected return; and β is the sensitivity of the
particular share to movements in the market return. Formally, β i's definition is: βi = cov(Ri,Rm)/σ2
(Rm) (2) where Ri is the return of the asset, Rm is the return of the market portfolio, and σ2m is the
market variance. This form of the CAPM is a specific case of the more generalised form: E(R i) = R
f + β i [ E(R m) – R f]+εi (3)
Where, βi the stock sensitivity to the market risk factor; and the residual return.
5.2.4.6.2. Fama and French Three Factor Model
Fama and French (1992) contend for a multifactor model and their three factor asset pricing model
is an extension of a single factor CAPM. Fama and French three factor model includes two
additional factors to account size and value premia along with market risk.

Chapter 9: Multifactor Models of Risk and Return. (QUESTIONS) 1. Both the capital asset pricing
model and the arbitrage pricing theory rely on the proposition that a no–risk, no–wealth investment
should earn, on average, no return. Explain why this should be the case, being sure to describe
briefly the similarities and differences between CAPM and APT. Also, using either of these theories,
explain how superior investment performance can be establish.
Answer:
Both the Capital Asset Pricing Model and the Arbitrage Pricing Model rest on the assumption that
investors are reward with non–zero return for undertaking two activities:
(1) committing capital (non–zero investment); and (2) taking risk. If an investor could earn a
positive return ... Show more content on Helpwriting.net ...
6. It is widely believed that changes in certain macroeconomic variables may directly affect
performance of an equity portfolio. As the chief investment officer of a hedge fund employing a
global macro–oriented investment strategy, you often consider how various macroeconomic events
might impact your security selection decisions and portfolio performance. Briefly explain how each
of the following economic factors would affect portfolio risk and return: (a) industrial production,
(b) inflation, (c) risk premia, (d) term structure, (e) aggregate consumption, and (f) oil price.
Answer:
The value of stock and bonds can be viewed as the present value of expected future cash flows
discounted at some discount rate reflecting risk. Anticipated economic conditions are already
incorporated in returns. Unanticipated economic conditions affect returns.
Industrial production: Industrial production is related to cash flows in the traditional discounted cash
flow formula. The relative performance of a portfolio sensitive to unanticipated changes in industrial
production should move in the same direction as the change in this factor. When industrial
production turns up or down, so too shares in the return on the portfolio. Portfolios sensitive to
unanticipated changes in industrial production should be compensated for the exposure to this
economic factor.

The Capital Asset Pricing Model Essay
Q.22: DISCUSS CAPM (WILLIAM SHARPE'S MODEL) WITH ITS ASSUMPTIONS. ALSO
EXPLAIN THE CONCEPTS OF CML AND SML. (EXPLAIN THE SINGLE INDEX MODEL
PROPOSED BY WILLIAM SHARPE.)
ANS.: INTRODUCTION
CAPM tells how assets should be priced in the capital markets if, indeed, everyone behaved in the
way portfolio theory suggests. The capital asset pricing model (CAPM) is a relationship explaining
how assets should be priced in the capital market.
The capital asset pricing model (CAPM) is a widely–used finance theory that establishes a linear
relationship between the required return on an investment and risk. The model is based on the
relationship between an asset 's beta, the risk–free rate (typically the Treasury bill rate) and the
equity risk premium (expected return on the market minus the risk–free rate).
This model was developed by William F. Sharpe (1990 Nobel Prize Winner in Economics) and John
Lintner in 1960. The model attempts to capture market behavior. It is simple in concept and has real
world applicability. The model is based on the promise that the systematic risk attached to a security
is the same irrespective of any number by security in the portfolio. The total risk of the portfolio is
reduced with increase in number of stocks as a result of decrease in the unsystematic risk
distribution over number of stocks in portfolio.
The CAPM is an alternative approach to the problem of measuring the cost of capital. This model
attempts to measure the relationship between risk

Advantages Of The Capital Asset Pricing Model
The capital asset pricing model (CAPM) was proposed by Sharpe (1964) –Lintner (1965) whom had
relied on the Markowitz mean–variance–efficiency model, in the mean – variance –efficiency model
investors are supposed to be risk–averse during one time period and they only care about the
expected returns and the variance of returns (risk). These investors choose only efficient portfolios
with minimum variance, given expected return, and maximum expected return, and variance. The
Expected returns and variance plot a parabola, and points above its global minimum identify a
mean–Variance – efficient frontier of risky assets. Sharpe–Lintner CAPM theory turns the mean–
variance model into a market–clearing asset–pricing model. The assumptions of the model ... Show
The Time frame (which referred to frequency of returns and historical time period used) for the
regression of the historical data greatly impacts the estimation of the beta. The limitation of the
concept of volatility, which is referred to the magnitude of changes in prices. The unclear base on
which we choose forecast of the risk–free rate ( r RF ) and the required rate of return for the market
( r m ). Arbitrage Pricing Theory (APT): APT was proposed by Rose (1976), the Assumptions of the
theory are as follow: (1) Investors are targeting maximize their return. (2) Borrowing and lending is
according to the riskless rate. (3) The market is free from restrictions which could be transaction
costs, taxes, or restrictions on short selling. (4) Investors agree on the number and identity of the
priced factors. (5) the excess Riskless profitable in compare with the risk–free rate are immediately
arbitraged away. Arbitrage Pricing Theory posits a single–factor security market Rose

Capital Asset Pricing Model (Capm)
Introduction Capital asset pricing has always been an active area in the finance literature. Capital
Asset Pricing Model (CAPM) is one of the economic models used to determine the market price for
risk and the appropriate measure of risk for a single asset. The CAPM shows that the equilibrium
rates of return on all risky assets are function of their covariance with the market portfolio. This
theory helps us understand why expected returns change through time. Furthermore, this model is
developed in a hypothetical world with many assumptions. The Sharp–Lintner–Black CAPM states
that the expected return of any capital asset is proportional to its systematic risk measured by the
beta. (Iqbal and Brooks, 2007). Based on some simplifying ... Show more content on
Helpwriting.net ...
This creates a new line, the security market line (SML). The SML can be used to determine an
asset's expected return, given its beta. According to the formula, the portfolio's expected return
equals the rate earned on risk–free assets plus the amount of risk taken (measured by beta) times the
market risk premium. In the CAPM, betas are generally estimated from the stock's characteristic line
by running a linear regression between past returns on the stock in question and past returns on
some market index. Bringham and Ehrhardt (2005) define betas developed in this manner as
historical betas. However, Fama and French (1992) argue about the reliability of beta in explaining
the differences in expected returns. According to their studies, they have found empirical evidence
that firm size, book–to–market, and earnings–to–price have significant explanatory power for
average returns, calling into question the descriptive validity of the CAPM of Sharpe (1964), Lintner
(1965), and Black (1972). The validity of the CAPM is questioned because of the CAPM posits a
positive linear relation between ex ante expected returns and betas, while other firm specific
variables such as firm size, book–to–market, and earnings–to–price should not have any ability to
explain average cross–sectional returns. The empirical evidence of Fama and French thus
contradicts the CAPM. The Fama and French study

Testing the Capital Asset Pricing Model Essay
Testing the Capital Asset Pricing Model And the Fama–French Three–Factor Model By Jiaxin Ling
(Cindy) March 19, 2013 Key words: Asset Pricing, Statistical Methods, CAPM, Fama–French
Three–Factor Model Abstract: This paper examines the Capital Asset Pricing Model(CAPM) and the
Fama–French three–factor model(FF) and the Fama–MacBeth model(FM) for the 201211 CRSP
database using monthly returns from 25 portfolios for 2 periods –––July 1931 to June 2012 and July
1631 to June 2012. The theory's prediction is that the intercept should equal to zero the slope should
be the excess return on the market portfolio. The findings of this study are not substantiating the
theory's claim for the fact that in some portfolios the alpha is ... Show more content on
Helpwriting.net ...
3) One may observe that the data in period two is a sub period of period one and the beta is not
stable over time for more portfolios have less than unit value beta in period two and some portfolios
tend to be more volatile in the whole period (July 1931 to June 2012) but in sub period (July 1963 to
June 2012) is less volatile than market level, take portfolio 24 as an example: its beta is 1.14 in
period one and in period two its beta is 0.83. 2. The OLS cross–sectional test of the CAPM The
CAPM states that the securities plot on the Security Market Line (SML) in equilibrium. We do
cross–sectional test is to identify whether the above statement is true with our two data set and
whether or not it rejects the hypothesis that the slope is zero. In the equation 3, the gamma 0 is the
excess return on a zero beta portfolio and gamma 1 (the slope of the regression) is the market
portfolio's average risk premium. [pic] (3) We perform the OLS cross–sectional test of equation (3)
for both two periods. The results have shown in Table 3that gamma1 in time period 1 is positive
(0.55) and it is statistically significant for its p value is 0.05, which implies that it rejects the null
hypothesis of zero slope of the model. The gamma0 is also positive (0.26) which suggests that the
cross–sectional return of 25 sample portfolios during July 1931

Capital Asset Pricing Model Of Wotif.com Holdings Limited
FINC2011 Essay
Executive Summary This report provides a valuation of Wotif.com Holdings Limited (WTF)
through adoption of the Capital Asset Pricing Model and calculation of the beta value. We shall also
use the Constant dividend growth model and determine the growth of the company's dividend. The
results of the data shows that
Question 1: Wotif.com Holdings Limited is an online hotel reservation website. It provides services
of hotel reservation, flight booking and holiday packages. It has its main operations set in The
company is listed as ASX200 on the Australian Securities Exchange (Australian Securities
Exchange 2014). Its main operations are in Australia but also has businesses located in Canada,
Malaysia, New Zealand, Singapore ... Show more content on Helpwriting.net ...
This independency reduces probability of failure of all ventures, lowering chances of losing large
percentages of their wealth. Diversified investors are risk averse, and as a result more agreeable to
accepting lower returns per investment. To determine required returns, the total risk exposed to the
investor's portfolio must be evaluated. By looking at the investor's portfolio, we can determine the
specific risk unique to that portfolio. We also need to take into account of the market risk that all
portfolios are exposed to. These two risks make up the total risk (Mad Fientist 2012). Figure 1.1 –
Capital Asset Pricing Model As shown in the figure 1.1 (adapted from Stock Analyst K 2010), the
efficient frontier and capital market line intersects at M. Along the efficient frontier line, there exists
portfolios with highest returns at a given level of risk. These portfolios are categorized as efficient
portfolios. Different investors have different tolerances levels relative to returns, and would pick an
investment portfolio along the efficient frontier according to the amount of risk they are willing to
uptake. A risk free asset is also included in figure 1.1, and labelled as rf. A risk–free asset is an asset
with no risk, and is used to expand the risk–return opportunities available for

Capital Asset Pricing Model and Return
––––––––––––––––––––––––––––––––––––––––––––––––– CHAPTER 24
––––––––––––––––––––––––––––––––––––––––––––––––– Portfolio Theory, Asset Pricing
Models, and Behavioral Finance Please see the preface for information on the AACSB letter
indicators (F, M, etc.) on the subject lines. True/False Easy: (24.4) SML FN Answer: b EASY . The
slope of the SML is determined by the value of beta. a. True b. False (24.4) SML FN Answer: a
EASY . If you plotted the returns of Selleck & Company against those of the market and found that
the slope of your line was negative, the CAPM would ... Show more content on Helpwriting.net ...
c. The beta of "the market," can change over time, sometimes drastically. d. Sometimes the past data
used to calculate beta do not reflect the likely risk of the firm for the future because conditions have
changed. e. There is a wide confidence interval around a typical stock's estimated beta. (24.5) Beta
coefficient CN Answer: d EASY . Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the
following statements must be true about these securities? (Assume market equilibrium.) a. When
held in isolation, Stock A has greater risk than Stock B. b. Stock B must be a more desirable addition
to a portfolio than Stock A. c. Stock A must be a more desirable addition to a portfolio than Stock B.
d. The expected return on Stock A should be greater than that on Stock B. e. The expected return on
Stock B should be greater than that on Stock A. Medium: (24.2) Market equilibrium CN Answer: a
MEDIUM . For markets to be in equilibrium (that is, for there to be no strong pressure for prices to
depart from their current levels), a. The expected rate of return must be equal to the required rate of
return; that is, . b. The past realized rate of return must be equal to the expected rate of return; that
is, . c. The

Introduction
The Capital Asset Pricing Model ("CAPM") was introduced by Sharpe (1964), Lintner (1965) and
Mossin (1966) to provide investor an understanding in relation to the expected returns of their
investment. However, this theory has been criticised by some empirical models resulted from the
unrealistic assumptions. This paper will critically analyse the limitation of the CAPM and will
discuss Arbitrage Pricing Theory ("APT") and Fama–French ("FF") Three–Factor Model ("TFM")
as the possible alternative empirical approaches.
This paper will be organised as follows: Section one: Introduction; Section two: An overview of
CAPM and its limitations; Section three: An overview of APT and TFM and how to overcome
CAPM limitations; Section four: Conclusion.
Capital Asset Pricing Model ("CAPM")
CAPM is simple period model that demonstrates the linear relationship between systematic risk of
an asset and expected market return. The formula of CAPM is
E(ri)=r_f+βi[E(rm)–r_f]
Where:
E(ri)=Required return on asset i r_f=Rate risk–free of the return βi=Beta of asset i
E(rm)= Average return of market
The general idea behind CAPM is that investors need to be compensated in two ways: time value of
money and risk. The time value of money is represented by the risk–free rate (r_f) in the formula
and compensates the investors for placing money in any investment over a period of time. The other
half of the formula represents risk and calculates the amount of compensation

The Capital Asset Pricing Model Essay
Discussion on the application of CAPM
Introduction
The capital asset pricing model, also called CAPM, is created by William Sharpe, John Lintner, Jack
Treynor and Jan Mossin in 1964, aiming to study the decision process of security price in the
market. With proper assumptions on investors' behavior, the capital asset pricing model pays the
most attention to the exploration of quantified relationship between security return and the risk.
However, academic community is turning away from the classical model and tries to analyze the
relationship with other tools. This essay will mainly discuss the reasons why academic community
is avoiding the CAPM. In addition, the relationship between risk and return will firstly be explained.
More details on fundamental features of the CAPM will be given out. Empirical evidence will be
adopted to illustrate the CAPM.
The relationship between risk and return
Risk comes from the uncertainty of things. The investment risk is the changing possibility of
expected return, including the general market risk and the security specific one. Return is the part
which equals to the inflow of investment opportunity minus the outflow. Theoretically, the
relationship of risk and return can be depicted as the expected return which equals to the risk–free
return adding the risk premium. Generally, based on the capital market line, the higher the expected
return is, the higher the risk is. Under different environments and conditions, the risks of different

Consider Capital Asset Pricing Model
Name: Li XU Morning group: PGA15 Project group: Management 02 Date: 30/08/2016
Consider the capital asset pricing model. What are the theoretical underpinnings of this model?
What can you say about the empirical implications of this model?
The CAPM (capital asset pricing model) is a model used to evaluate a theoretically appropriate
required rate of return of an asset in finance field, providing information to investor to make
decisions about investment portfolios and guide investors' investment behaviours (McLaney, 2006).
The CAPM was invented by William F. Sharpe, John Lintner and Jan Mossin, basing on the earlier
work of Harry Markowitz on diversification and modern portfolio theory, and now it is universally
applied (Vernimmen, et ... Show more content on Helpwriting.net ...
At the beginning of the discussion, definition of CAPM will be introduced. The CAPM is an
essential model in financial management, it makes contributions to establishing the foundation of
modern financial theory and research. This model based on two important lines.
The capital market line (CML) represents the risk–return combinations for investors to choose the
best investment portfolio with the risk–free asset in an efficient market. It defines the risk/return
trade–off for efficient portfolios. The risk of this equation is all systematic risk (Pike et al, 2012).
The security market line (SML) consists of the return of a risk–free asset and a premium risk which
related to the market's own risk premium. This equation shows the expected rate of return of an
individual security and the risk is measured by beta (Pike et al, 2012).
The beta is a measure of risk arising which indicates whether the investment is more or less unstable
than the market. The greater the beta that shows a particular security, the higher the expected returns
of the security (McLaney, 2006).
All the theoretical underpinnings rely on the assumptions. The CAPM is always regarded as an
unrealistic model because the assumptions which the theory bases on are difficult to satisfy, so it is
necessary to understand these assumptions and explain why they are always criticised by
economists.
Now, these factors mentioned above will be explained more specifically. There are six

Essay on Capital Asset Pricing Model
James D. Lowe
Trident University International
FIN301 – Principles of Finance
Module 3
Case Assignment
Assignment:
1. For each of the scenarios below, explain whether or not it represents a diversifiable or an
undiversifiable risk. Please consider the issues from the viewpoint of investors. Explain your
reasoning
a. There's a substantial unexpected increase in inflation.
b. There's a major recession in the U.S.
c. A major lawsuit is filed against one large publicly traded corporation.
2. Use the CAPM to answer the following questions:
a. Find the Expected Rate of Return on the Market Portfolio given that the Expected Rate of Return
on Asset "i" is 12%, the Risk–Free Rate is 4%, and the Beta (b) for Asset "i" is 1.2. ... Show more
Diversifiable risk
The entire economy will not be affected; in fact some companies in areas not affected by the lawsuit
will benefit as they will be able to fill a void in the market as the company in question faces legal
precedings.
2. Use the CAPM to answer the following questions:
a. Find the Expected Rate of Return on the Market Portfolio given that the Expected Rate of Return
on Asset "i" is 12%, the Risk–Free Rate is 4%, and the Beta (b) for Asset "i" is 1.2.
CAPM (Capital Asset Pricing Model equation is: r A= r f + beta A (r m – r f) risk free rate= r f = 4%
beta of stock= beta A= 1.2 return on market portfolio= r m = to be determined required return on
stock r A = 12.00%
Therefore, r m = 10.666% =(12.%–4.%)/1.2+4.%
Answer: return on market portfolio= 10.666%
b. Find the Risk–Free Rate given that the Expected Rate of Return on Asset "j" is 9%, the Expected
Return on the Market Portfolio is 10%, and the Beta (b) for Asset "j" is 0.8.

CAPM (Capital Asset Pricing Model equation is: r A= r f + beta A (r m – r f) risk free rate= r f =
beta of stock= beta A= 0.8 return on market portfolio= r m = 10% required return on stock r A = 9%
Therefore, r f = 5 % =(0.8*10.–9.)/(0.8–1)
Answer: risk free rate= 5 %
c. What do you think the Beta (ß) of your portfolio would be if you owned half of all the stocks
traded on the major exchanges? Explain.
The beta would be close to 1
This is

Capital Asset Pricing Model and Arbitrage Pricing Theory
Capital Asset Pricing Model and Arbitrage Pricing Theory: Capital Asset Pricing Model (CAPM) is
an arithmetical theory that describes the relationship between risk and return in a balanced market.
The Capital Assets Pricing Model was autonomously and simultaneously developed by William
Sharpe, Jan Mossin, and John Litner. The researches of these founders were published in three
different and highly respected journal articles between 1964 and 1966. Since its inception, the model
has been used in various applications that range from public utility rates to corporate capital
budgeting. However, the initial introduction of the model was characterized by suspicious view from
the investment community. This was largely because CAPM apparently indicated that professional
investment management was hugely a waste of time. Due to its implementation problems and
shortcomings associated with its relation to Arbitrage Pricing Theory, Capital Asset Pricing Model
has continued to face constant academic attacks. Overview of Capital Asset Pricing Model: Since its
introduction, the Capital Asset Pricing Model offers a huge portion of the justification for the
tendency toward reactive investing in large index mutual funds (Cooper and Cousins, n.d.). After the
initial suspicious view of CAPM, investment professionals changed their perspective nearly a
decade later to view the model as a vital tool that assist investors to understand risk. Actually, the
development of this model not only

Capital Asset Pricing And Discounted Price Flow Models Essay
Capital Asset Pricing and Discounted Price Flow Models
Knowing the risk of an investment and understanding how that risk will affect any future returns are
crucial aspects in deciding if the expected return is worth the risk. The Capital Asset Pricing Model
(CAPM) provides a base from which both the risk and the affects of the risk are determined by the
investor while the Discounted Price Flow Model (DPCM) can help the investor decide what amount
they are willing to invest in a company in anticipation of projected future cash flows. As indicated in
the previous paragraph, the Capital Asset Pricing Model is a tool used in determining the risk of an
investment and in turn, deciding if the risk is worth the investment. The CAPM ... Show more
The DPFM gives a bona fide stock value because it does weigh all of the inputs unlike other
avenues such as P/E's and price–to–sales ratios in which stocks are compared to one another rather
than judged on intrinsic values. (Investopedia)
Debt Equity Mix
The cost of debt is equivalent to the interest rate a corporation, and individual, or a household is
paying on all of its debt such as loans or bonds. Debt is inclusive of repayment later, just as savings
can be used later. It is believed that corporations with higher debt are frequently the riskier
conglomerates. The risky behavior of some businesses can sometimes be attractive to potential
investors, while causing others to shy away. Household debt unfolds similarly to that of major
corporations, but on a smaller scale. While the bulk of credit in a household is extended in the form
of mortgages, a lot dwells in the plastic credit cards. Unfortunately, credit is often used to bridge the
gap in income or temporary drops and can ultimately cause the debt of a household to increase
substantially. Credit cards often enable some households the consumption of possibilities that would
not otherwise be around.
The characteristics of debt or one's income path help determine the growth of the market, increased
interest rates, and timing. Debt differs from assets in many ways because it is in nominal

The Theory Of Capital Asset Pricing Model

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