This document provides an overview of the Capital Asset Pricing Model (CAPM). It defines key terms like systematic and unsystematic risk. It explains that CAPM considers only systematic risk and uses the beta coefficient to measure risk. It also describes the security market line and capital market line graphs that are used in CAPM. The document outlines the assumptions of CAPM and notes both the benefits and drawbacks of using the model to determine expected returns based on an asset's risk level.

2. CONTENTS
• FEW TERMS
• CAPITAL ASSET PRICING MODEL
• BETA COEFFICIENT
• SECURITY MARKET LINE
• CAPITAL MARKET LINE
• ASSUMPTION OF CAPM
• BENEFITS OF CAPM
• DRAWBACKS OF CAPM
• CONCLUSION

3. FEW TERMS
RISK-RETURN TRADE OFF
• ALSO KNOWN AS RISK-RETURN SPECTRUM OR RISK-REWARD
• RELATIONSHIP BETWEEN RISK AND RETURN
EXPECTED RETURN
• IT IS IN EXCESS OF THE RISKLESS RATE
• BENEFIT FOR INVESTING IN THAT INVESTMENT OPPORTUNITY
• IT IS FOR THE FUTURE PERIOD

4. FEW TERMS
SYSTEMATIC RISK
• RISK OF THE ENTIRE MARKET AS A WHOLE
• DAY-TO-DAY FLUCTUATIONS IN STOCK’S PRICES
• IT IS AN UN-DIVERSIFIED RISK
UNSYSTEMATIC RISK
• RISK OF AN INDIVIDUAL COMPANY OR INDUSTRY
• IT DEPENDS COMPLETELY ON THE COMPANY
• IT IS DIVERSIFIED

5. CAPITAL ASSET PRICING MODEL
• IT CONSIDERS ONLY SYSTEMATIC RISK
• EXPLAINS THE BEHAVIOUR OF SECURITY PRICES
• SUGGEST THE DETERMINATION OF PRICES OF SECURITIES
• REFERS THAT THE SECURITIES ARE VALUED IN LINE
CAPM : 𝐸 𝑅𝑖 = 𝑅𝑓 + β (𝑅 𝑚 − 𝑅𝑓)

6. BETA COEFFICIENT
• RISK MEASUREMENT FACTOR
• NEGATIVE BETA WOULD BE HIGHLY UNLIKELY
β=1
Market Risk β>1
Higher Riskβ<1
Lesser Risk

7. SECURITY MARKET LINE
• EXPRESSES THE BASIC THEME OF THE CAPM
• IT IS AN UPWARD SLOPING STRAIGHT LINE WITH AN
INTERCEPT AT THE RISK-FREE RETURN SECURITIES
AND PASSES THROUGH THE MARKET PORTFOLIO.
• IT DISPLAYS THE EXPECTED RATE OF RETURN OF AN
INDIVIDUAL SECURITY.
𝐸 𝑅𝑖 = 𝑅𝑓 + β (𝑅 𝑚 − 𝑅𝑓)

8. CAPITAL MARKET LINE
• IT IS A TANGENT LINE DRAWN FROM THE POINT OF
RISK-FREE ASSET.
• IT REPRESENTS THE MARKET PORTFOLIO, SINCE ALL
RATIONAL INVESTORS SHOULD HOLD THERE RISKY
ASSET IN THE SAME PROPORTIONS AS THEIR
WEIGHTS IN THE MARKET PORTFOLIO.
𝐸(𝑟) = 𝑟𝑓 + σ
𝐸 𝑟 𝑀 − 𝑟𝑓
σ 𝑀

9. ASSUMPTIONS
ALL INVESTORS :-
• AIM TO MAXIMIZE ECONOMIC UTILITIES
• ARE RATIONAL
• ARE DIVERSIFIED
• ARE PRICE TAKERS
• CAN LEND AND BORROW UNLIMITED AMOUNT
• TRADE WITHOUT TRANSACTION AND TAXATION COST
• DEALS WITH HIGHLY DIVISIBLE SECURITIES
• HAVE HOMOGENEOUS EXPECTATIONS
• ALL INFORMATION IS AVAILABLE AT THE SAME TIME

10. BENEFITS OF CAPM
THERE ARE FEW ADVANTAGES TO THE APPLICATION OF CAPM
•EASE-OF-USE
•DIVERSIFIED PORTFOLIO
•SYSTEMATIC RISK
•BUSINESS AND FINANCIAL RISK VARIABILITY

11. DRAWBACKS OF CAPM
THE PRIMARY DRAWBACKS ARE REFLECTED IN THE MODEL’S INPUTS AND
ASSUMPTIONS :-
•RISK-FREE RATE
•RETURN ON THE MARKET
•ABILITY TO BORROW AT A RISK-FREE RATE
•DETERMINATION OF PROJECT PROXY BETA

12. CONCLUSION
NO MATTER HOW MUCH WE DIVERSIFY OUR INVESTMENTS, IT’S IMPOSSIBLE TO GET RID OF ALL THE RISKS.
AS INVESTORS, WE DESERVE A RATE OF RETURN THAT COMPENSATES US FOR TAKING ON RISK. THE CAPITAL
ASSET PRICING MODEL HELPS US TO CALCULATE INVESTMENT RISK AND WHAT RETURN ON INVESTMENT
WE SHOULD EXPECT.
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