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What Is The CAPM (Capital Asset Pricing Model) And Of What Practical Use Is It?
Finance & Accounting
Pages 6 (1506 words)
The total risk of portfolio can be divided into systematic (non-diversifiable) and unsystematic (diversifiable) risk. An investor can reduce the unsystematic risk of investment through proper diversification of securities in the portfolio.
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 expected rate of return for an asset relative to market risk. Using the CAPM model an investor can eliminate the unsystematic risk through proper diversification by estimating the required rate of return for a given level of non-diversifiable or market risk. The practical application of the model is that the individual investor will be able to modify their investment portfolio according to their risk taking behaviour. The model also helps the individuals to analyse the risk-return profile in the portfolio (Gallagher and Andrew, 2007, pp.173-175). ...
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