1083 Words5 Pages

Capital Asset Pricing Model

Capital Asset Pricing Model (CAPM) is used to calculate the projected return on the equity of a single company. CAPM is based on risk free rate, the expected return rate on the market and beta coefficient of a single portfolio and security.

Re = Rf + β [E(Rm) - (Rf)]

According to the formula, Re represents the Return on Equity, Rf is for the risk-free rate, E(Rm) denoted to expected rate of return on the market, and β is the beta coefficient and E(Rm) - Rf is the difference among the expected market rate of return and the risk-free rate, is known as the market premium (Phillips, 2007).

The total risk of stock is divided in two parts: the systematic risk, which is risk linked with the market and is impossible to*…show more content…*

CAPM is basically used to confirm the theoretically suited required rate of return to the asset when the asset is considered to be added towards a well performing existing portfolio. Capital Market Line is used for determining the return rate of specific efficient portfolios. Basically, this analysis depends on risk free return rate and amount of the risk involved within particular portfolio. Its formula is shown as:

CML∶E (r)=rf+ σ (E (rM)- rf)/σM

Capital market line is the result from a combination of market portfolio as well as risk free security or asset (which is L point). All the points along CML have greater risk and return profiles to any portfolio at efficient frontier, along with an exception of Market Portfolio that is the point on efficient frontier towards which the Capital market Line is tangent. From the perspective of CML, the M portfolio is composed entirely of the market and risky asset, as well as has not holding of risk free asset, that is, the money is actually neither invested, nor taken or borrowed from account of money market. The points to left and above of CML are considered infeasible, whereas the points to below or right are actually attainable but are inefficient. The point R denotes addition of the leverage that creates the levered portfolio which is also at CML (Snyder,*…show more content…*

This is the main point of similarity among Capital Asset Pricing Model and the Capital Market line. Basically, the Capital Asset Pricing Model (CAPM) is significant part of the portfolio theory, which discusses capital market line and security market line. Thus, the CAPM is served as base for both CML and SML.

On the other hand, there exists point of difference at several points when we talk about the CAPM and CML. First, Capital Market Line is line which is used for the rate of return that depends upon the risk free return rate and risk level for a particular portfolio. However, Security market line which is formed by CAPM is denoted as Characteristic line. It is graphical representation of risk and the return of market at given time. Second, in Capital Market Line, standard deviation is used for the risk measurement of a portfolio and in the Security market line, the beta coefficient is used to find out about factor of risk. Third, the graph of Capital market Line demonstrates about only efficient portfolios; while the graph of Security Market Line demonstrates both efficient and the non-efficient portfolios. Fourth, when take measurement of risk factors, the CML is considered as superior this is not in the case of SML. Fifth, Capital Market Line only determines the risk free assets and market portfolio; whereas, Security market

Capital Asset Pricing Model (CAPM) is used to calculate the projected return on the equity of a single company. CAPM is based on risk free rate, the expected return rate on the market and beta coefficient of a single portfolio and security.

Re = Rf + β [E(Rm) - (Rf)]

According to the formula, Re represents the Return on Equity, Rf is for the risk-free rate, E(Rm) denoted to expected rate of return on the market, and β is the beta coefficient and E(Rm) - Rf is the difference among the expected market rate of return and the risk-free rate, is known as the market premium (Phillips, 2007).

The total risk of stock is divided in two parts: the systematic risk, which is risk linked with the market and is impossible to

CAPM is basically used to confirm the theoretically suited required rate of return to the asset when the asset is considered to be added towards a well performing existing portfolio. Capital Market Line is used for determining the return rate of specific efficient portfolios. Basically, this analysis depends on risk free return rate and amount of the risk involved within particular portfolio. Its formula is shown as:

CML∶E (r)=rf+ σ (E (rM)- rf)/σM

Capital market line is the result from a combination of market portfolio as well as risk free security or asset (which is L point). All the points along CML have greater risk and return profiles to any portfolio at efficient frontier, along with an exception of Market Portfolio that is the point on efficient frontier towards which the Capital market Line is tangent. From the perspective of CML, the M portfolio is composed entirely of the market and risky asset, as well as has not holding of risk free asset, that is, the money is actually neither invested, nor taken or borrowed from account of money market. The points to left and above of CML are considered infeasible, whereas the points to below or right are actually attainable but are inefficient. The point R denotes addition of the leverage that creates the levered portfolio which is also at CML (Snyder,

This is the main point of similarity among Capital Asset Pricing Model and the Capital Market line. Basically, the Capital Asset Pricing Model (CAPM) is significant part of the portfolio theory, which discusses capital market line and security market line. Thus, the CAPM is served as base for both CML and SML.

On the other hand, there exists point of difference at several points when we talk about the CAPM and CML. First, Capital Market Line is line which is used for the rate of return that depends upon the risk free return rate and risk level for a particular portfolio. However, Security market line which is formed by CAPM is denoted as Characteristic line. It is graphical representation of risk and the return of market at given time. Second, in Capital Market Line, standard deviation is used for the risk measurement of a portfolio and in the Security market line, the beta coefficient is used to find out about factor of risk. Third, the graph of Capital market Line demonstrates about only efficient portfolios; while the graph of Security Market Line demonstrates both efficient and the non-efficient portfolios. Fourth, when take measurement of risk factors, the CML is considered as superior this is not in the case of SML. Fifth, Capital Market Line only determines the risk free assets and market portfolio; whereas, Security market

Related

## Single Index Model And Capital Asset Pricing Model

1129 Words | 5 PagesLintner further explained that CAPM predicts a tradeoff between systematic risk known as beta and expected return under specific conditions CAPM makes correct forecast about expected return as shown by the formulae below; E(Ri) = Rf + beta-of-i (Rm - Rf) Similarities Both the SIM and CAPM represent market movement of stock. They both further focus on the balanced relationship between the risk and expected return on risky assets. Even the functional form for the expected return is similar for both the two models. The alpha as show by the symbol α found in both formulae highlights a similarity between the two models. The alpha or the abnormal return of stock of a portfolio is the average of the alphas of the individual securities.

## Arbitrage Pricing Model Case Study

768 Words | 4 PagesIt expands portfolio theory and helps us to calculate the unexpected risk of asset. As long as we know the risk-adjusted expected return of the asset, we can assess the asset's price as correct. Although CAPM allows us to determine the rate of return required for any risky asset to determine its price, but CAPM is actually used primarily to evaluate common stock. Use the CAPM it may requires some assumptions, including the following: There is risk-free asset so that investors can lend or borrow at a risk-free rate of return. Investors agree on the expected rate of return and probability of these returns.

## Similarities And Differences Between The Single Index Model And Capital Asset Pricing Model

1217 Words | 5 PagesThe 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.

## Capital Asset Pricing Model Research Paper

1600 Words | 7 PagesThe Capital Asset Pricing Model is for the most part utilized by money related organizations, and monetary security organizations, to see regardless of whether a speculator ought to go for broke, or if the stock he as of now possesses is underestimated or exaggerated, in different terms, when to offer and when not to offer stock, and regardless of whether to purchase it (or go out on a limb). The Theory is likewise used to gauge organizations costs as far as their value capital. Organizations likewise utilize it as an apparatus or technique for measuring an organizations money related markets value securities and along these lines decide expected profits for their capital. As a general synopsis to the majority of that The general thought behind CAPM is for speculators to be prize in two routes for their venture: time estimation of cash and hazard, this implies they get a reasonable measure of cash regarding the danger rate and the time estimation of the cash he contributed. At the point when connected the financial specialist is prize for the cash he/she contributed over a timeframe, furthermore the additional sum he/she as far as the danger.

## Capital Asset Pricing Model: A Case Study

1398 Words | 6 PagesWhat is CAPM According to Rabeea Sadaf and Sumera Andleeb (2014), the capital asset pricing model (CAPM) is a tool can be apply to define a theoretically appropriate required Rate of Return of an asset. The CAPM was developed by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965a, b), according to them the systematic risk need to consider when investor calculating a deserved return as it is uncontrollable and unavoidable even they diversified away; for the unsystematic risk of that asset can be assumed zero because stock's return that is not correlated with general market moves. The CAPM concept states that the return on an individual stock, or a portfolio of stocks have to equal its cost of capital which then is a linear

## Case Study On Maslow's Hierarchy Of Needs

1461 Words | 6 PagesHow can you apply the CAPM model to Strategy, Marketing and HR? Strategy. First, the CAPM idea on taking risk or not for every investment would be a help if one must understand the formula itself. Investors would invest if they can assure the stability of CAPM. Cost of capital in connection to the capital budgeting using Net Present Value for any projected project or investment would be a factor for any successful industry with long-term goals and strategic design.

## Advantages Of Arbitrage Pricing Theory

1012 Words | 5 PagesEvidences show that the two models differ substantially in their assumptions even though they might share certain attributes such as using assumptions to substantiate how assets should be priced. While CAPM is concerned with the finding of equilibrium of the market by holding optimal portfolio as suggested by the portfolio theory, APT adheres to the finding of the same equilibrium but by ruling out arbitrage possibilities (Krause, 2001). It therefore allows the inclusion of other sources either than market risk. As Fama and French (1992; 1993) asserted that other variables are even able to explain the observed returns or changes in the stock prices better than the market risk and could therefore be a framework to find a justification of these changes on a sound theoretical

## Executive Summary: The Capital Market In Canada

1908 Words | 8 PagesIntroduction “Capital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions.” (Times, n.d.) As it describe capital market is the market which trade with the medium-long-term financing, the trade usually use the securities such as bonds,stock etc. The actor of the capital market are the companies but the intitution also use the capital market, such as the government. How does the capital market work ? The capital market consist with the two markets, the primary market and secondary market.

## Bear Spread Case Study

1913 Words | 8 PagesThe maximum potential loss of the bull spread is limited to the amount paid for the premiums of the two options, or in other words amount paid to enter the bull spread position. Due to the fact that the value of the bull spread is not dependent on implied volatility, which his possible to anticipate up to some degree, and that it is rather dependent on other market factors, this strategy is usually employed by veterans and experienced traders. These people are able to anticipate to what point the price of a particular stock will go up and decide whether to take a long position or employ the bull spread and make a profit on a temporary price increase. Bear Spread Second type of a vertical spread is a bear spread. Traders usually employ this strategy when they believe that the price of the underlying financial asset will go down.

## Fama-French Three-Factor Model Case Study

846 Words | 4 PagesIn order to capture risk premiums better than with CAPM Fama and French developed The Three-Factor model. The variables are based on prior evidence and predict well average returns. There are two easily measured variables in addition to the beta, Small Minus Big and High Minus Low. Small Minus Big, often referred as SMB, is a factor trying to capture the size premium and according to Fama and French it works as proxy for risk. High Minus Low, otherwise known as HML, is a proxy for risk that value stocks carry.

### Single Index Model And Capital Asset Pricing Model

1129 Words | 5 Pages### Arbitrage Pricing Model Case Study

768 Words | 4 Pages### Similarities And Differences Between The Single Index Model And Capital Asset Pricing Model

1217 Words | 5 Pages### Capital Asset Pricing Model Research Paper

1600 Words | 7 Pages### Capital Asset Pricing Model: A Case Study

1398 Words | 6 Pages### Case Study On Maslow's Hierarchy Of Needs

1461 Words | 6 Pages### Advantages Of Arbitrage Pricing Theory

1012 Words | 5 Pages### Executive Summary: The Capital Market In Canada

1908 Words | 8 Pages### Bear Spread Case Study

1913 Words | 8 Pages### Fama-French Three-Factor Model Case Study

846 Words | 4 Pages