What Is The CAPM (Capital Asset Pricing Model) And Of What Practical Use Is It? Investment Risk And Return: Concept Analysis. - Essay Example

Extract of sample
What Is The CAPM (Capital Asset Pricing Model) And Of What Practical Use Is It? Investment Risk And Return: Concept Analysis.

On September 28, 2008 CNN reported, “The day's loss knocked out approximately $1.2 trillion in market value, the first post-$1 trillion day ever (CNN Money 2008 p. 1).” The above facts explain that investment in the security market is associated with the risk; sometime its magnitude is no less than the worst volcanic eruption or earthquake. The consequences of financial crashes create enormous damage in individuals’ plus country’s economic condition. Nevertheless, people keep investing in the security market. The primary reason is the opportunity of getting a good return from the security market. For example, during 1992 – 2011, the average of returns of the S&P was 9.6 % (Forbes 2012). Regardless of stock market crashes many investors believe that leaving money in the high-yield saving accounts is not an investment at all. Nevertheless, investing money in the security market involves a significant amount of risks. The return of an investment is a function of risks; lower the risks lower the return, and higher the risks higher the return. Return and risk relationship at the conceptual level can be represented through a straight line shown in figure 1.An investment may encounter market risk, default risk, interest rate risks, liquidity risk, and political risks (Forbes 2012). These risks make an impact on the return of an investment. The capital asset pricing model studies the impact of risks on the return of an investment. ...
Download paper

Summary

In 1929 stock market crash, investors in today’s money, lost $319 billion dollars. The Black Monday of 1987 was the largest one-day market crash in the history. The primary reason is the opportunity of getting a good return from the security market…
Author : isadorekilback
Download 1

Related Essays

Investing in Portfolios and CAPM
If the investor chooses alternative 1 and invests all the money in Evergreen, then he can earn a return of 13.8%. Since Evergreen is a safe company, therefore the standard deviation of returns is quite low and risk coefficient is only 0.11. One must keep in mind that by investing in this company, the investor is foregoing chance of earning high returns. In other words, the investor is foregoing chance of earning high returns for increased safety by investing in this company. On the other hand, in the case of alternative 2, if the investor decides to invest in more dynamic of the two companies...
8 pages (2008 words) Essay
The Capital Asset Pricing Model (CAPM)
However lending has an interest rate attached to it. In the open market, it is also assumed that traders have all relevant information rates of stocks and other co-variances. Traders in an open market are also assumed to be rationale about being risk averse and all investors have same assets to choose from given all information concerning the assets and same decision methods are applied (Burton, 1998). This brings us to the concept of the capital asset pricing model (CAPM). The model is very useful and is widely used in the industry, although it is based on very strong assumptions. This paper...
5 pages (1255 words) Essay
"In finance, risk is best judged in a portfolio context." Is this true? Why
In such a case, if one project fails, the amount lost will be partially covered by the other project that succeeds. That way, one avoids losing all his or her money in one project. Investing in several projects to reduce the level of risk is referred to as spreading portfolio. Therefore, the term portfolio can be defined as a collection of investments that are held by an individual or by a company (Brealey, Myers & Allen, 2011). It is not easy to judge risk from a single investment. One investment may fail or it may succeed. There are a number of factors that contribute to the failure or...
6 pages (1506 words) Admission Essay
CAPM (Capital Asset Pricing Model) and Its Practical Use.
It is carried out through a properly designed and professional model that does not require to be completely renewed on a case by case basis. It has, therefore, met the requirements of the Asset Management industry in which the capacity to correctly price securities, and to properly infer the right rate of return. These are used to determine traditional and innovative alternative assets and provide all qualities that can make possible for a portfolio manager to gain an early lead over competitors (Brigham and Houston). The model, from a technical perspective, has been based on the works of Dr...
8 pages (2008 words) Essay
What Is The CAPM (Capital Asset Pricing Model) And Of What Practical Use Is It?
When the expected return of a security is determined using the model then it can be compared to the estimated return of security over a given time period. Such comparison will help the investor to analyse whether it is worthwhile investing into the security. CAPM was first conceptualised and pioneered by William Sharpe, Jack Treynor, Jan Mossin and John Lintner through their independent works (Focardi and Fabozzi, 2004, pp.86-87). The Capital Asset Pricing Model The Capital Asset Pricing Model (CAPM) is popularly used to price individual portfolio securities. The CAPM helps to determine the...
6 pages (1506 words) Essay
CAPM (Capital Asset Pricing Model)
and expected returns which is denoted as r. The ? is used as a measure of non diversified risk and implies that the expected return is the return on a risk free asset in addition to a risk premium (Laubscher, 2002). The risk premium will be equivalent to the market return in surplus of the risk free rate which is multiplied by the share portfolio. This is the reason that ? is regarded as the difference between the returns on various share portfolio. The formula for CAPM model is denoted below: R = Rf + ?(Rm - Rf) R = Expected return on the share/portfolio. Rf = Risk-free rate of return. ? =...
7 pages (1757 words) Essay
Capital Asset Pricing Model
Usually, the overall volatility of the market is measures through proxies when implementing this model, for instance, the use of FTSE index. Such proxies are not usually the true measures of the market volatility which is at the core of the CAPM assumptions. Therefore, the model estimations from CAPM with use of market proxies for volatility can only predictions that are approximates and not the accurate measures of risk and return relationships. Another unrealistic assumption the CAPM model makes is the existence of a free risk security. In reality, there is not security that is free from...
4 pages (1004 words) Assignment
Got a tricky question? Receive an answer from students like you! Try us!