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Financial Economics - Assignment Example
Author : xschmeler
Finance & Accounting
Pages 4 (1004 words)
Task A (a) In the capital asset pricing model there are assumptions which are made in order to apply the model. The assumptions of the model lead to many of the limitations of the model and circumstances where the application of the model is limited to a certain extent…
In order to apply the capital asset pricing model it is assumed that the investors are rational whereas the investors are not rational and all the investors does not have same information. There are cases in which the investors gets an inside information related to a certain investment and thus invests in that investment. One of the major limitation is that the investors can borrow or lend any amount for any period of time at the risk free rate which is not possible in practice as there are limitations and restrictions and it is difficult to determine the risk free rate for a long period of time as it is considered as the rate of the government securities which are considered to be least risky. Capital asset pricing model considers the assets to be perfectly divisible and is marketable which is not possible in all circumstances as there are not sudden markets available for all of the assets and securities and all the assets are not perfectly divisible. Capital asset pricing model considers that no transaction cost is incurred in the purchase and sale of the securities and thus limits the practical implication in which the transaction costs are bared by investors when buying or selling the securities (Fama & French, 2004). ...