ipl-logo

Capm Portfolio Theory

1066 Words5 Pages

3.2.3.2 The Portfolio Theory and the Capital Asset Pricing Theory (CAPM)
One of the most celebrated theories in financial economics is the Capital Asset Pricing Model (CAPM), a single-index asset pricing equilibrium model developed separately by Sharpe (1964), Lintner (1965) and Mossin (1966). CAPM has been very influential as it is widely used as a benchmark to measure the value of financial assets and capital budgeting projects as well as to assess fund managers‟ performance. Prior to CAPM, financial assets were mainly evaluated on the basis of their individual return whilst performance of investment funds were assessed mainly through relative measures such as fund ranking techniques due to the unavailability of a specific market equilibrium …show more content…

It depicts a linear relationship theory between return and risk (or mean-variance relationship) based on the underlying assumptions: (1) All investors are risk-averse and would choose an efficient portfolio that would maximise their end-of-period expected utility (the marginal utility decreases as wealth increases); (2) All investors have the same one-period investment horizon; (3) All investors measured portfolio performance solely based on mean and variance (return and risk) and they all have homogenous expectations on the distribution of the end-of-period future returns; (4) There is no friction in the trading of financial assets such as the absence of taxes or transaction costs, and that the financial market is informationally efficient; and, (5) All investors can choose to invest in any financial assets, and they may borrow or lend any amount of money at the rate similar to risk-free rates. Under these assumptions, the CAPM shows that the expected return for an asset or portfolio i is related to the expected excess return of the market portfolio adjusted for the systematic risk of the asset or portfolio, commonly represented …show more content…

Both methods are discussed in the following sections.
Portfolio Performance Measurements Based on the Mean-Variance Criterion
Prior to the CAPM, analysis of the mutual fund performance was based primarily on performance ranking techniques due to the unavailability of a benchmark against which the mutual fund performance can be compared. Through the CAPM, researchers were able to formulate an absolute measurement value to evaluate mutual fund performance.
The three most widely used risk-adjusted portfolio performance measures are the Treynor index (Treynor, 1965), the Sharpe index (Sharpe, 1966), and the Jensen-alpha index (Jensen, 1968). The three measures were principally derived from the CAPM equation. Friend and Blume (1970) provide a concise description of the derivation process. Assuming that all the CAPM assumptions hold, the financial market is said to be in equilibrium with the individual asset or portfolio (represented by the symbol i) poised to trade at their fair value price satisfying the general ex-ante CAPM as Equation 3 below:

Show More
Related

  • Kohl's Financial Analysis Paper

    427 Words  | 2 Pages

    The focus of this paper is to profile an authentic assessment on Kohl’s Corp. Kohl’s was organized in 1988 and the state of incorporation is Wisconsin. The nature of Kohl’s operation is a family-based, value-angled department store that focuses on selling modestly priced selected national brand apparel, including but not limited to footwear, various accessories, beauty and select home products. Their stores usually carry a steady merchandise assortment based regional preferences and demographics. Kohl’s has a website for shopping in store, as well as items only available for only on-line purchases. Kohl’s focus is to cater to in-store accessibility including locations close to home, nearby parking, trouble-free accessible entry, well informed

    Read More

  • Capital Purchase Case Study

    519 Words  | 3 Pages

    1. Describe the need for Capital Purchase. One significant capital cost for any department is a ladder truck. My example will outline some of the steps to replace an existing and aging ladder truck overdue for replacement according to pre-determined department policies and NFPA Standards.

    Read More

  • Capism Foundation Business Simulation Paper

    1472 Words  | 6 Pages

    The Capism Foundation business simulation consisted of six rounds leading to the game-ending position. Throughout the simulation, my group and I created a strategy that we thought would help maximize performance indicators such as return on sales, return on assets, return on equity, market share, earnings per share and net income. Our strategy was simple – first enter the low-tech market and then once ready, try occupying significant amounts of market share in the high-tech market. Once we established our strategy, we implemented the correct tactical execution from round-to-round by applying relevant course material and conducting the right research. At the end of the simulation, I believe that our company’s level of profitability and financial

    Read More

  • Should Healthcare Leaders Use Project Metrics And Portfolio Management

    344 Words  | 2 Pages

    Operational efficiency and effectiveness is highly desirable when it comes to new system implementations, and use of project metrics and portfolio management are the best ways to ensure that the new system meets the stringent operational efficiency and effectiveness criteria. I suggest that the healthcare leaders should use the use project metrics and portfolio management because: Characterization – Project metrics and portfolio management enables the leaders to understand the development process and establish baseline for future assessments. For example, when the healthcare organization opts for new EHR system, the projects metrics and portfolio management help the managers in assessing the ongoing implementation of HER system based on the

    Read More

  • Dollarama Company Case

    990 Words  | 4 Pages

    This is the measurement of the levels of investor confidence which influences the value of a firm in the

    Read More

  • When Genius Failed Summary

    735 Words  | 3 Pages

    The story of “When Genius Failed by Roger Lowenstein “is about Long Term Capital Management hedge stock investments from its creation to its fall. John Meriwether made the asset after he left from Salomon Brothers, the reason of his enormous wealth, the partners, and other investors. When they fell, it is firm toward the end. The book gives the reader of a thought of the realm in the world of international investment banking and bond and equities trading.

    Read More

  • Four Chapter Of Retail Party Economics

    662 Words  | 3 Pages

    An overall outlook on efficiency in financial markets can be defined as the correct goods being made for the correct people at the correct price(Adomait and Maranta 155). Market failure is highly related to financial markets because market failures happen in financial markets when the opportunity costs are strictly financial instead of also including personal preferences(Adomait and Maranta 155). Since firms tend to buy for cheap and sell for expensive, a spillover occurs(Adomait and Maranta 133). A spillover is an economic event in one context that

    Read More

  • Big Market Price

    414 Words  | 2 Pages

    Chapter one in the book present prices and weights of grocery in the big market. Following answers on questions on pages 6-8. I) 1. The list of prices declared in the big market did not change during the summer of 1995 2. The price of olives oil exceeds the price of corn oil by five dollars.

    Read More

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

    1217 Words  | 5 Pages

    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.

    Read More

  • Shareholder Wealth Case Study

    1954 Words  | 8 Pages

    Mergers and Acquisitions and Shareholder Wealth: The theory of finance states that maximization of shareholder wealth should be the goal of every business organization. It is not clear, however, whether maximization of shareholder wealth is the main motivation behind Mergers and acquisitions. This has generated a lot of research interest the area. Unfortunately decades of intensive research have not been able to conclusively establish the impact of Mergers and acquisitions on shareholder wealth.

    Read More

  • Walmart Capacity Planning Analysis

    1069 Words  | 5 Pages

    The satisfaction of these objectives contributes to the company’s performance in operations management. When these measures are later evaluated, it is easier to implement the control measures in place. Walmart Company uses a number of metrics to assess its performance; comparable store sales it indicates the performance of the existing stores by measuring the growth in sales for such stores for a particular period over the corresponding period in the prior year, operating income growth greater than net sales growth, inventory growth less than net sales growth and return on average assets must be

    Read More

  • Efficient Market Hypothesis Essay

    1444 Words  | 6 Pages

    Efficiency of financial markets is one of the fundamental issues in finance. The central idea of market efficiency is that market prices of securities represent true value of securities. All relevant information is immediately reflected in the prices causing abnormal profit making impossible in the market. The efficient market hypothesis further implies that prices will move randomly that makes prediction of prices extremely difficult. Efficient market hypothesis requires that investors will be rational and have homogenous expectation.

    Read More

  • Canadian Financial Market: Portfolio Analysis

    987 Words  | 4 Pages

    In the late 1970s and the early 1980s, the concept of “portfolio trading” or “program trading” was initiated to trade an “all-inclusive” portfolio, in most cases a portfolio that is made up of all the S&P 500 stocks in one order placed at a major brokerage firm (Gastineau, 2001). In the early 1990s, the development and innovation in technology along with the ever-increasing demand of trading in “all-inclusive basket” in the financial market pushed the creation of the first index-based funds with the characteristics of equity on the Canadian stock exchange markets (Deville, 2007). The advent of the Toronto Index Participation units (TIPs), which was designed to track the Toronto 35 index (TSE-35) gained huge popularity and attracted substantial investments not only in the domestic Canadian market but also from international investors (Gastineau, 2001). After three years of prosperity in the Canadian market, the first Exchange-Traded Fund in the U.S. market, known as the Standard & Poor’s Depository Receipts (SPY or SPDR) was introduced by the American Stock Exchange (AMEX) in 1993, with the goal of tracking the Standard & Poor’s 500 Index (Gastineau, 2001).

    Read More

  • Single Index Model And Capital Asset Pricing Model

    1129 Words  | 5 Pages

    Lintner 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.

    Read More

  • Harry Markowitz's Theory Of The Modern Portfolio Theory

    943 Words  | 4 Pages

    Portfolio choice Modern portfolio theory More than 60 years ago Harry Markowitz established a whole new concept for optimizing portfolios, by focusing on a holistic approach of several assets to build a portfolio rather than to restrict the investment to a single seemingly profitable asset. In his article “Portfolio selection” from 1952, he derived a normative decision rule to build efficient portfolios. With this decision rule, he laid the foundation for a theory, which was later called the modern portfolio theory. About 40 years later in 1990 Harry Markowitz won the Nobel prize together with Merton H. Miller and William F. Sharpe for their pioneering work in the theory of financial economics.

    Read More

More about Capm Portfolio Theory

Open Document