StudentShare solutions
Triangle menu

Capital Asset Pricing Model - Essay Example

Not dowloaded yet

Extract of sample
Capital Asset Pricing Model

The Capital Asset Pricing Model (CAPM) is a liaison involving risk and return on a portfolio of investments. Sharpe, William F (1964, pp. 425-442) formulated the CAPM hypothesis. It is the groundwork of modern finance which puts forward that the risk premium of a single asset is equal to its beta times the risk premium of the market portfolio on the whole. Beta computes the level of inter-movement of the asset's return and the total return on the entire market portfolio of an investor. Put differently, beta measures the organized risk of an asset which is nothing but the quantity of risk and it cannot be spread.
Frank J. Fabozzi and Harry Markowitz (2002, p.67) define CAPM as "The anticipated return for an asset according to CAPM is equal risk free rate plus a risk premium". They further state that "even though the idea is not true it does not mean that the constructs introduced by the theory are not important. Constructs introduced in the development of theory include the notion of a market portfolio, systematic risk, diversifiable risks and beta."
The entire movement of the market is enlarged with stocks which possess betas greater than 1.0. Stocks which have betas between 0 and 1.0 are inclined to go in the same route as the market. Certainly, the market is the collection of all stocks, and hence the standard stock has a beta of 1.0
Risk is best adjudicated in the context of a portfolio of securities. Part of the ambiguity about a sureties return is branched out when security is sorted with other assets in a portfolio. It can be said that diversification is the best for the investors undoubtedly. This does not entail that business firms have to diversify. Corporate variegation is superfluous if capitalists can broaden on their personal account. Frank J Fabozzi and Pamela P Peterson (2003, p 299) state that "Though it lacks realism and is difficult to apply, the CAPM makes some sense regarding the role of diversification and the type of risks we need to consider in investment decisions."
When an asset does contain a factor of market risk, CAPM submits that it should make a risk premium impartial to the sum of market risk mused in the asset. If the fundamental market has an amount of return vagueness, it can be assumed that the market return will be greater than the risk gratis return. This is the surplus market return. To obtain the additive surplus return, the marked is levered with the market return either up or down by the level of market risk disclosure intrinsic in the asset (Bruce J Feible, 2003, p. 192).

The most frequently used gauge of risk or unpredictability in finance is standard deviation. This is because 'the return on a portfolio is a weighted average of the returns of individual assets' ...Show more


The kind of investments made evaluates the amount of risk on investments to an investor. Since investors averse risk they always like to be on the safer side by making more payment for safety but getting less in return. Actually risk taking is connected to a greater amount of earnings and to attract investors risky investments offer greater returns.
Author : gusikowskitierr
Capital Asset Pricing Model Essay essay example
Read Text Preview
Save Your Time for More Important Things
Let us write or edit the essay on your topic
"Capital Asset Pricing Model Essay"
with a personal 20% discount.
Grab the best paper

Related Essays

Capital asset pricing model
Risk free rate + ? (Average Market Return –Risk free rate) Where ? is the beta value of the financial asset The basic assumptions of this model pose as disadvantageous for this model to be considered as a perfect representative of required return calculation.
1 pages (250 words) Essay
Capital Asset Pricing Model
This concept holds that an investor’s time value of money and level of risks must be considered while rewarding him. These factors are generally computed using a risk measure called beta. Although the CAPM is widely used for anticipating the feasibility of an investment decision, this model has a number of corporate applications also.
7 pages (1750 words) Essay
CAPM (Capital Asset Pricing Model)
Capital Asset Pricing Model. CAPM (Capital Asset Pricing Model) The CAPM model has emerged to be one of the most important tools in making a fundamental decision related to the investment management. It measures the relationship between the expected rate of return and the risk involved in a particular investment The CAPM tool signifies the linear relationship between the non diversified systematic risks which is measured by beta ?
7 pages (1750 words) Essay
Capital asset pricing model
The model assumes that the lending rate and the borrowing rate are equal. In practice, these two rates differ and therefore, the model will not hold in a real life scenario. also Also it assumes that there is no transaction cost, taxes or holding period of the securities.
4 pages (1000 words) Essay
The Capital Asset Pricing Model
It is essentially used to price the most risky assets. As a mathematical model for equilibrium in financial markets and portfolio theory (Markowitz), the CAPM core basis is the relationship that exists between the risk of a security and its yield, and it is measured through a single beta factor for risk (Plesmann, 2010.p.54).
4 pages (1000 words) Essay
Capital Asset Pricing Model
Despite these efforts, it is evident that risks remain a vital and its mitigation needs to be properly consummated. Aside from these concepts, the financial world is also familiar with the term uncertain. Essentially, this refers to the incapability of providing comprehensive list of outcomes and indefinite probabilities.
10 pages (2500 words) Essay
Capital Asset Pricing Model Master Essay
Several academicians and scholars have argued on the empirical validity of the CAPM theory and claim that the model has several technical and empirical problems [Fama and French (2004), Michailidis (2006), Ryan (2006), (Soufian, 2001) etc]. There are several criticisms on the empirical effectiveness of the CAPM theory viz.
6 pages (1500 words) Essay
Corporate Financial ,ESSAY TOPIC :Outline and discuss the Capital Asset Pricing Model (CAPM) as means of valuing securities and their risk. What are the drawbacks with the CAPM and how does it compare and interact with the dividend valuation model
But nevertheless the degree of this imperviousness is determined by a number of other factors that are inherent to the system itself (Saunders, 1999). Calculations involve the same process as above. CAPM is
8 pages (2000 words) Essay
About Capital Asset Pricing Model
CAPM works under a series of key assumptions. The first assumption is that there are no transaction costs which mean that investors
8 pages (2000 words) Essay
Capital asset pricing model (CAPM)
The paper "Capital asset pricing model (CAPM)" gives the detailed information about Developments in the Capital Asset Pricing Model. The foundation of Capital asset pricing model was established in an article of a finance journal in the year 1963 named, Capital Asset Prices: A theory of market equilibrium under conditions of risk.
7 pages (1750 words) Essay
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
Your email
Comments (0)
Rate this paper:
Thank you! Your comment has been sent and will be posted after moderation