StudentShare solutions

# CAPM - Assignment Example

## Extract of sampleCAPM

CAPM has theoretical limitation, which include impractical assumptions and instability of the beta values. The Arbitrage Pricing Model and Rolls have criticized the theory indicating that it may be unreliable and invalid. This study will examine the theoretical limitations and criticisms of the theory. Theoretical Limitations of the Theory The theory argues that all investors are risk avoiders and that the returns are normally distributed (Ma, 2011). This is not the case because investors are normally risk takers who are willing to make huge returns when their predictions favor them and lose when they fail. Assuming that returns are normally distributed is also unfounded because investors are not usually sure of the yields on their assets (Ma, 2011). The assumption that assets are free from risk is also unrealistic because it is hard to find such stocks in the real world. The theory argues that short-term securities offered by the government are free from hazards because the state assures investors certain returns on the assets. This is not the case because the risk on the assets is in the form of inflation, which is the instability of prices in the market (Ma, 2011). Inflation leads to the loss of value of money, and this means that, assets also lose their worth when prices rise in the economy. Since money loses its value then it means that investors face the risk of lower returns when their stock matures. For example, when the state pays 10% on its short-term bonds then inflation rises in the country by 2%, investors get 8% returns on their securities in real terms. This means that investors face the risk of inflation, which reduces their earnings. This also indicates that the CAPM model is applicable in an ideal world, an occurrence that is impossible (Ma, 2011). Roll’s Critique of CAPM Roll criticizes the validity of the Capital Asset Pricing Model equation. The equation is as indicated below: E(Ri) =RF +?i [E(RM) - RF] Where E(Ri) represents the yield on security i. RF is the risk free rate of return. Bi is the market risk that security i faces. Roll’s first critique was that the model could not be tested using current data because it is constructed based on historical data. The impossibility of testing the model arises from the fact that it is based on market values of stocks, real estates, jewelers, and labor. Rolls argue that it is impossible to find the market value of this portfolio because no accurate data of these factors exists in reality. Thus, Roll argues that the CAPM cannot be proven right or wrong because of the impossibility of getting accurate data (Ma, 2011). Roll argues that economic models should be easy to test using future data because they simplify the real life. However, according to him, CAPM is complex because of the inability of being tested using future data, and this makes it unreliable. Roll also postulates that it is impossible to get efficient stocks whose values and rates of return have linear relationships ideally (Ma, 2011). Therefore, Rolls argument generally argues that CAPM is unreliable because it has never been tested using real data, and it is still impossible to do so because of uncertainty of prices, which is common in the real world. Arbitrage Pricing Model (APM) The APM addresses the weaknesses of CAPM by doing away with the assumption that the ...Show more

## Summary

Capital Asset Pricing Model (CAPM) Professor Institution City and State Date Capital Asset Pricing Model (CAPM) CAPM is a financial theory that aims at calculating the yields of a stock while taking into consideration the risk of the asset. The hypothesis argues that the expected return on an asset is linearly related to the systematic risk and the risk free rate of return, multiplied by the hazardous premium (Ma, 2011)…
Author : faheykacey
Save Your Time for More Important Things
Let us write or edit the assignment on your topic
"CAPM"
with a personal 20% discount.
Grab the best paper

### Related Essays

Corporate finance
In this respect, a popular model designed by Sharpe (1964) and Lintner (1965) had explained this relationship as Capital asset Pricing Model (CAPM). The main idea of this model involves only one risk factor, the excess market portfolio return. In this model, the variation in the excess portfolio return is explained by the covariance of the market portfolio return with the portfolio return.
6 pages (1500 words) Assignment
Capital Asset Pricing Model
The CAPM model therefore relies on the ability to measure market volatility as a whole. With several possible investments available in the market, the model assumes that one can accurately assess the volatility of each of these investments. This is impossible.
4 pages (1000 words) Assignment
Critically analyse the capital asset pricing model (CAPM) and arbitrage pricing theory (APT) models.your analysis may include drawing simlarities ,difference and weakness of the models in relation to real life practical situations .MBA FINACCE SUBJECi
The idea of investing in the financial market is to purchase the asset while the price is low, and to sell when the price appreciates. The seeming arbitrary movement of prices of assets, such as stocks, has
12 pages (3000 words) Assignment
Critically analyse the relative merits of the Capital Asset Pricing Model and empirical approaches to Asset pricing (such as FAMA and French model)
The objective of the study is to critically analyse the merits of the CAPM, the challenges that this is facing in the global economy and also to focus on the other
6 pages (1500 words) Assignment
Portfolio Theory's underpinning principles need to be uncovered before appreciating the ceration of capital asset pricing model ( CAPM ), Evaluate the reason why investors should establish portfolios
stment in one asset or security and should diversify the investment by investing in a group of assets so that the loss from one security can be compensated by the gain of the other security. The gain achieved from one asset can offset the loss incurred from the other only if
6 pages (1500 words) Assignment
Capital budgeting, Risk, Return, CAPM
This gives the importance of purchasing the3 instrument via a loan which is more profitable to the company. b) In no case should Darth have leased the Death star for any case because leasing will always be expensive for
3 pages (750 words) Assignment
Capital Asset Pricing Model
The risk free rate is the government bond ideally, that has a fix ten years. The Beta is the true measure of the risk that is in the stock that one has invested on. With the risk in it, measure the volatility of the investment. It is in this
1 pages (250 words) Assignment
CAPM
Guided through these assumptions, this model provides a precise prediction about the relationship between risk and return. This paper herewith intends to explain the answer of
4 pages (1000 words) Assignment
CAPM
hout a significant decrease in returns, and the need to select the most profitable portfolios, the importance and correctness of CAPM is often questioned. This paper examines the importance and correctness of the model by drawing from various financial concepts and
4 pages (1000 words) Assignment
A central assumption made in Mean-Variance Analysis and the Capital Asset Pricing Model (CAPM) is that investors prefer to invest in the most efficient portfolios available
To start with, we will understand the concept of an efficient portfolio as described below. Most investors, according to mean-variance analysis and asset pricing model, tend to invest in a more efficient portfolio
6 pages (1500 words) Assignment
Get a custom paper written
by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger