Submitted By namrata9457

Words 761

Pages 4

Words 761

Pages 4

1. Introduction 3

2. CAPM 3

3. Global CAPM 4

4. International CAPM 4

5. Conclusion 5

6. Reference 5

According to the survey conducted among the most successful US enterprises, 73-85% of the respondent claims to use CAPM as their preferred methodology (Desai, 2005), thereby making CAPM most widely used model to estimate cost of equity. CAPM model is used to estimate the expected return on a risky asset by adding to the risk free rate of return a market risk premium. Sharpe and Lintner built CAPM theory on basis of Markowitz theory of mean- variance portfolio model.

1. Assumption of CAPM

Markowitz mean- variance analysis refers to the theory of combining risky assets so as to minimize overall risk of the portfolio at desired level of return. The Markowitz theory is based on three assumption i.e. all investors minimize risk for desired level of expected return or demand additional return for additional risk (risk averse), all parameter of individual asset like expected returns, variance and covariance are known thereby all investors have same expectations of all asset parameter and there are no taxes or transaction cost. Sharpe and Lintner add two key assumptions to the Markowitz model to derive CAPM - individual buy and sell decision does not affect asset price (price takers) and investors can borrow and lend unlimitedly at risk free rate.

2. Limitation of CAPM Assumption

The assumption that the investor consider only expected return, variance and covariance of asset in the portfolio is not practical, as the investors also consider the relation of their portfolio return with labour income and future investment opportunities that would be offered by the market.

CAPM assumes that all investor have same portfolio, thereby implying that all investor have same time horizon for holding a portfolio, which is not the…...

... returns for each of these factors The sensitivity of the stock to each of the factors( Note: the sensitivity of a stock is likely to change overtime) Ross and others identified the following macro-economic factors they felt played a significant role in explaining the return of a stock: Inflation GNP or Gross National Product Investors’ Confidence Shifts in the Yield Curve However APT is still striving to overcome the argument of Capital Asset Pricing Model with its flaws which includes; extraction of a number of common factors from a large portfolio’s, transforming theoretical Capital Asset Pricing Model to testable relationships, and the fundamental weakness is the failure of the APT to discriminate between factor representations. However the advantage APT has over Capital Asset Pricing Model is the ability to accommodate several sources of systematic risk. APT makes a lot of sense because it removes Capital Asset Pricing Model restrictions and basically states “The expected return on an asset is a function of many factors as well as sensitivity of the stock to these factors CAPITAL ASSET PRICING MODEL The model was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. CAPM model states that the price of a stock is tied on two variables: the time value of money and the risk of the stock...

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...Table of Contents 1. Introduction 3 2. CAPM 3 3. Global CAPM 4 4. International CAPM 4 5. Conclusion 5 6. Reference 5 According to the survey conducted among the most successful US enterprises, 73-85% of the respondent claims to use CAPM as their preferred methodology (Desai, 2005), thereby making CAPM most widely used model to estimate cost of equity. CAPM model is used to estimate the expected return on a risky asset by adding to the risk free rate of return a market risk premium. Sharpe and Lintner built CAPM theory on basis of Markowitz theory of mean- variance portfolio model. 1. Assumption of CAPM Markowitz mean- variance analysis refers to the theory of combining risky assets so as to minimize overall risk of the portfolio at desired level of return. The Markowitz theory is based on three assumption i.e. all investors minimize risk for desired level of expected return or demand additional return for additional risk (risk averse), all parameter of individual asset like expected returns, variance and covariance are known thereby all investors have same expectations of all asset parameter and there are no taxes or transaction cost. Sharpe and Lintner add two key assumptions to the Markowitz model to derive CAPM - individual buy and sell decision does not affect asset price (price takers) and investors can borrow and lend unlimitedly at risk free rate. 2. Limitation of CAPM Assumption The assumption that the investor consider only...

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...On the Use of the CAPM in Public Utility Rate Cases: Comment Author(s): Dennis E. Peseau and Thomas M. Zepp Reviewed work(s): Source: Financial Management, Vol. 7, No. 3 (Autumn, 1978), pp. 52-56 Published by: Wiley on behalf of the Financial Management Association International Stable URL: http://www.jstor.org/stable/3665011 . Accessed: 08/02/2013 07:25 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp . JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. . Wiley and Financial Management Association International are collaborating with JSTOR to digitize, preserve and extend access to Financial Management. http://www.jstor.org This content downloaded on Fri, 8 Feb 2013 07:25:31 AM All use subject to JSTOR Terms and Conditions Utility Regulation and the CAPM: A Discussion On the Use of the CAPM Cases: in Comment Public Utility Rate Dennis E. Peseau and Thomas M. Zepp The authors are Senior Economists on the staff of the Oregon Public Utility Commissioner. * In a recent issue of Financial Management...

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...Derivation of the Capital Asset Pricing Model - CAPM [pic] E(xi) expected return on the asset i r risk free rate E(xm) expected return on the market portfolio (S&P index) (i i-th asset’s systematic risk (a proportion of market risk) Optimal investment proportions - each individual investor on the market attempts to reach the highest feasible market line. The Market line can be found by minimising the standard deviation (o for any given portfolio‘s expected return E(xo). [pic] [1] [pic] [2] where pi is the proportion of the portfolio invested in i-th asset. Define the function C as follows [pic] [3] where ( is a Lagrange multiplier, and the expression in brackets equals zero. We are trying to find the optimal proportion of each asset, which minimises the risk of optimal portfolio. The Market line can be found analytically by differentiating equation [3] with respect to each pi and with respect to Lagrange multiplier and setting the first derivatives equal to zero. This yields n+1 equations. [pic] [4.1] [pic] [4.2] [pic] [4.3] [pic] [4.4] Let’s now take the set of equations [4.x] and multiply them by p1, p2 etc. We obtain: [pic] [5.1] [pic] [5.2] … [pic] [5.3] [pic] [5.4] If we sum up the equations [5.1] to [5.3], we obtain [pic] [6] The term in the bracket on the left-hand side is a variance of the optimal portfolio (o2. Substituting it for the bracketed expression on the LHS...

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...HBS CASE STUDY Bankruptcy and Restructuring at Marvel Entertainment Group Why did Marvel file for Chapter 11? Were the problems caused by bad luck, bad strategy or bad execution? We believe that Marvel filed for Chapter 11 mainly because of its bad business strategy. As of year-end 1995, Marvel had 6 business lines: Sports and Entertainment Cards, Toys, Children's Activity Stickers, Publishing, Confectionery and Licensing of characters. Trading cards, Stickers and Comic Books started facing the decline in sales after year 1993. There were 2 main reasons for this decline: First, these businesses increasingly had to compete with alternative forms of child entertainment (mainly video games). Second, the decline in sales was driven by disappointed collectors who had viewed comic books as a form of investment and stopped buying them as company stopped increasing the prices. We believe that the company should have foreseen these events pregnant with dangerous consequences, while performing a market research and forming a long-term business and financial strategy. As one can see from the diagram below, the three unpromising business lines (filled in red colors) accounted to 61% of total revenues of a company in year 1995. At the same time, the company's financial strategy was based on highly optimistic business expectations and was not suitable for unfavorable turn of demand for entertainment products towards video games. Due to its high leverage (52%), the company was not...

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...CAPM essay In the second scenario BBBY would use its $400 million in excess cash and borrow the remaining funds until Question 2 a) We will need to calculate the debt-to GDP ratio for each year separately in order to compute the total accumulation. The following equations and variables are used in question a) ∆b=g-t+r-y* b g-t=2 i=3 π=1 r=i-π=3-1=2 y=1 b=0,9 (=90%) Year 1 ∆b=2+2-1* 0,9=2,9 byear 1=90+2,9=92,9 Year 2 ∆b=2+2-1* 0,929=2,929 byear 2=92,9+2,929=95,829 Year 3 ∆b=2+2-1* 0,95829=2,95829 byear 3=95,829+2,95829=98,78729 Year 4 ∆b=2+2-1* 0,9878729=2,9878729 byear 4=98,78729+2,9878729=101,7751629 Year 5 ∆b=2+2-1* 1,017751629=3,017751629 byear 5=101,7751629+3,017751629=104,792914529 Therefore, after 5 years the debt-to-GDP ratio will be equal to 104,8 % (rounded to one decimal) b) The debt is not sustainable. The criteria to test whether debt is sustainable is as follows: ∆b=g-t+r-y* b=0 Plotting in the known variables results in the following: ∆b=2+2-1* b=2+b= 0 Solving for b gives the following: b= -2 Therefore, the initial debt should be -200% (so surplus) in order to maintain a sustainable debt. c) If the nominal interest rate rises to 10%, it would imply that the real interest rate is as follows: r=i-π=10-π Therefore, we know that: ∆b=g-t+r-y* b=2+10-π-1*0,9=2+9-π*0,9 The criteria to maintain a sustainable debt is as follows: ∆b=0 This implies that ∆b= 2+9-π*0,9=0 Solving for inflation results in...

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...CAPM METHOD IN ASSESSING RISK AND RETURN OF SHARES TO DETERMINE INVEST IN SHARE OPTIONS JAKARTA ISLAMIC INDEX PERIOD JANUARY 2004-DECEMBER 2008 STOCK EXCHANGE IN INDONESIA Yesica Yohantin Undergraduate Program, Faculty of Economics Gunadarma University http://www.gunadarma.ac.id Keywords: Risk, Return, Beta, CAPM, Investment, JII Stocks ABSTRACT To form portfolio efficient stock, we shall have knowledge how risk which must be accounted and how big return which can we obtain after accounting the risk. Method Capital Assets Pricing Models (CAPM) applicable to analyze risk and return stock. This research aim to analyze calculation CAPM in value of risk and return and choice invests best at JII stocks. Data which is used to in this research is secondary data in the form of closing price monthly stock (monthly closing price), JII Price Index and interest rate monthly SBI. All data is calculated with CAPM method, tested by hypotheses by using of simple linear regression analysis and is processed by using of SPSS 17. Research sample consists of 9 JII stock entering by continues in stock list JII time line 2004-2008, that is ANTM stock, BUMI, INTP, INCO, KLBF, TBBA, TLKM, UNVR, and UNTR. Node result of research is there 5 aggressive stock that is INCO, TBBA, UNTR, ANTM, BUMI, and INTP ; 6 stock having excess positive return that is ANTM, BUMI, INTP, INCO, TBBA, and UNTR ; and there are 6 stock (almost entirely) which having correlation positive linear and β significant that...

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...Introduction to Finance Return, Risk, and the Security Market Line COMM 298 Outline 1 Portfolios 2 Portfolio Expected Return 3 Portfolio Variance 4 Systematic Risk, Speciﬁc Risk, and Diversiﬁcation 5 Market Portfolio and Measure of Systematic Risk 6 CAPM: From Risk to Return COMM 298 Return, Risk, and the Security Market Line 1 / 54 Outline 1 Portfolios 2 Portfolio Expected Return 3 Portfolio Variance 4 Systematic Risk, Speciﬁc Risk, and Diversiﬁcation 5 Market Portfolio and Measure of Systematic Risk 6 CAPM: From Risk to Return COMM 298 Return, Risk, and the Security Market Line 1 / 54 Portfolios Investors are risk averse. COMM 298 Return, Risk, and the Security Market Line 2 / 54 Portfolios Investors are risk averse. To reduce risk, it is good idea “not to put all your eggs in one basket”. COMM 298 Return, Risk, and the Security Market Line 2 / 54 Portfolios Investors are risk averse. To reduce risk, it is good idea “not to put all your eggs in one basket”. This is achieved by building a portfolio, which is a collection of assets. COMM 298 Return, Risk, and the Security Market Line 2 / 54 Portfolios Investors are risk averse. To reduce risk, it is good idea “not to put all your eggs in one basket”. This is achieved by building a portfolio, which is a collection of assets. The process is called diversiﬁcation...

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...Copyright c 2005 by Karl Sigman 1 Capital Asset Pricing Model (CAPM) We now assume an idealized framework for an open market place, where all the risky assets refer to (say) all the tradeable stocks available to all. In addition we have a risk-free asset (for borrowing and/or lending in unlimited quantities) with interest rate rf . We assume that all information is available to all such as covariances, variances, mean rates of return of stocks and so on. We also assume that everyone is a risk-averse rational investor who uses the same ﬁnancial engineering mean-variance portfolio theory from Markowitz. A little thought leads us to conclude that since everyone has the same assets to choose from, the same information about them, and the same decision methods, everyone has a portfolio on the same eﬃcient frontier, and hence has a portfolio that is a mixture of the risk-free asset and a unique eﬃcient fund F (of risky assets). In other words, everyone sets up the same optimization problem, does the same calculation, gets the same answer and chooses a portfolio accordingly. This eﬃcient fund used by all is called the market portfolio and is denoted by M . The fact that it is the same for all leads us to conclude that it should be computable without using all the optimization methods from Markowitz: The market has already reached an equilibrium so that the weight for any asset in the market portfolio is given by its capital value (total worth of its shares...

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...Yasmeen Iman Snow Deforest Thompson Gary Oha CAPM Yasmeen Iman Snow Deforest Thompson Gary Oha CAPM Contents Overview of CAPM 1 Advantages and Limitations 3 Breakthroughs and Setbacks 4 Works Cited 6 Overview of CAPM The CAPM was introduced by Jack Treynor , William F. Sharpe , John Lintner and Jan Mossin in 1964, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory (Fama & French, 1982). Sharpe, Markowitz and Merton Miller jointly received the 1990 Nobel Memorial Prize in Economics for this contribution to the field of financial economics. Fischer Black developed another version of CAPM, called Black CAPM or zero-beta CAPM that does not assume the existence of a riskless asset. This version was more robust against empirical testing and was influential in the widespread adoption of the CAPM (Fama & French, 1982). CAPM has become very attractive as a tool that measures risk to possible in relation to expected return, although it is still widely used for estimating the cost of capital for firms and evaluating the performance of managed portfolios. While CAPM is accepted academically, there is empirical evidence suggesting that the model is not as profound as it may have first appeared to be. CAPM’s empirical fallings arise theoretically from many over simplified assumptions made by the model. This has made it difficult to implement valid test for this model (Kristina...

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...‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’ MN 3365 Strategic Finance Table of Contents Introduction Concept of CAPM Assumptions of CAPM . Other Suggested Models Disadvantages of CAPM Advantages of CAPM Problems in applying CAPM Conclusion Bibliography / References INTRODUCTION This essay will highlight the use of Capital asset pricing model ( CAPM ) to be considered as a pricing theory model for assets . CAPM model helps investors to analyse the risk and what expectation to keep from an investment (Banz , 1981) . There are two types of risk associated with CAPM known as systematic and unsystematic risk . The systematic risks are market risk which cannot be diversified such as fluctuations in interest rates and recession in the economy .Unsystematic risk are risks associated with an individual stock , it occurs when an investor increases the number of stocks on his portfolio. The unsystematic risk cannot be diversified as it is related an individual stock irrespective to the general market . (Amihud and Lev, 1981). The CAPM was introduced independently by Jack Trenor (1961 , 1962) , Jan Mossin (1996) and William F . Sharpe (1964) , it is basically an uplifment of the existing work of Harry Markowitz on modern portfolio therory as well as diversification which was given a name...

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...Description of CAPM. The Capital Asset Pricing Model CAPM was introduced by Treynor ('61), Sharpe ('64) and Lintner ('65). By introducing the notions of systematic and specific risk, it extended the portfolio theory. In 1990, William Sharpe was Nobel price winner for Economics. "For his contributions to the theory of price formation for financial assets, the so-called Capital Asset Pricing Model (CAPM)." The CAPM model says that the expected return that the investors will demand, is equal to: the rate on a risk-free security plus a risk premium. If the expected return is not equal to or higher than the required return, the investors will refuse to invest and the investment should not be undertaken. CAPM decomposes a portfolio's risk into systematic risk and specific risk. Systematic risk is the risk of holding the market portfolio. When the market moves, each individual asset is more or less affected. To the extent that any asset participates in such general market moves, that asset entails systematic risk. Specific risk is the risk which is unique for an individual asset. It represents the component of an asset's return which is not correlated with general market moves. According to CAPM, the marketplace compensates investors for taking systematic risk but not for taking specific risk. This is because specific risk can be diversified away. When an investor holds the market portfolio, each individual asset in that portfolio entails specific risk. But through...

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...sdf Calculating Returns: CAPM vs. DCF Kalen Hickey American Military University The Capital Asset Pricing Model (CAPM) and Discounted Cash Flows Method are different techniques for determining returns on an investment. These concepts deal with the time value of money and the other investment factors. “If decisions are made that ignore the interaction of scale and risk, then cash flows are misvalued and suboptimal operations decisions are made” (Lederer & Mehta). Companies use CAPM and DCF to figure out the greatest potential for highest yield of an investment based on average market returns. The Capital Asset Pricing Model (CAPM) takes the two factors of time value of money and market risk into account for determining risk of investment and returns. “One is the risk of being in the market which is called systematic risk. The other-unsystematic risk-is specific to a company’s fortunes” (Burton, p.20). The two risks are married together, otherwise one would expect to see a positive return on every risk which is never the case. The expected rate of return for the CAPM takes into account risk-free interest rate, a stock beta that determines the relationship between the entire market and an individual investment, and an expected return from a typical market such as the Dow Jones. “The formula states that the expected return of a stock is equal to the risk-free rate of interest, plus the risk associated with all common stocks (market premium risk), adjusted...

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...CAPITAL ASSET PRICING MODEL What is CAPM actually? Capital Asset Pricing Model, popularly known as CAPM, is a model that provides a framework to determine the required rate of return in an asset and indicates the relationship between return and risk of the asset. This definition is given in books. Collectively it is somewhat indiscernible. We will dissect the definition. It is commonly known that the higher the risk, the higher the return. Now, suppose we know how much risky the asset is. This model will show us how much return should be there for the asset. This return is usually known as required rate of return and it is helpful to fairly evaluate the asset. This required rate of return can be compared with estimated rate of return. Thus, we will be able to know whether the asset is fairly evaluated or not. To understand relationship between risk and returns of the asset, Security Market Line (SML) can be used. Mr. Sharpe has created this CAPM model and to make it easily operational, he has made some assumptions. These assumptions may seem unrealistic, but to explain any economic or finance theory, they are essential. Market efficiency Sharpe has assumed that market is efficient, which means everyone reads either Economic Times or Business Standard or Mint and has all information about market and her/his shares. Everyone holds small amount of wealth and s/he cannot influence market. One holds handful of water and the market is an ocean. Risk aversion and...

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...Q . If you were advertising manager and wanted to advertise a new DVD player to people. What type of appeals could you use? What type of media could you used to reach the target audience? Advertisement is the non personal communication of information usually persuasive in nature about product services or idea by identified sponsor through the various media. Advertising intends to promote the sales of a product or service and also to inform the masses about the highlights of the product or the service features. It is an efficient means of communicating to the world, the value of the product or the service. Advertising utilizes different media to reach out to the masses and uses different types of appeals to connect to the customers across the globe. The various types of advertising appeals harness different means of highlighting the features of a product and drawing the attention of the masses towards it. Here is an overview of the different types of advertising appeals. Advertising intends to promote the sales of a product or service and also to inform the masses about the highlights of the product or the service features. It is an efficient means of communicating to the world, the value of the product or the service. Advertising utilizes different media to reach out to the masses and uses different types of appeals to connect to the customers across the globe. The various types of advertising appeals harness different means of highlighting the features of a product and...

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