...The Capital Asset Pricing Model: An Overview Email Icon Email Print Icon Print Posted: Nov 24, 2010 | Reprints Icon Reprints Filed under Economics Financial Theory Ben McClure Contact | Author Bio Advertisement No matter how much we diversify our investments, it's impossible to get rid of all the risk. As investors, we deserve a rate of return that compensates us for taking on risk. The capital asset pricing model (CAPM) helps us to calculate investment risk and what return on investment we should expect. Here we look at the formula behind the model, the evidence for and against the accuracy of CAPM, and what CAPM means to the average investor. Birth of a Model The capital asset pricing model was the work of financial economist (and, later, Nobel laureate in economics) William Sharpe, set out in his 1970 book "Portfolio Theory And Capital Markets." His model starts with the idea that individual investment contains two types of risk: Systematic Risk - These are market risks that cannot be diversified away. Interest rates, recessions and wars are examples of systematic risks. Unsystematic Risk - Also known as "specific risk," this risk is specific to individual stocks and can be diversified away as the investor increases the number of stocks in his or her portfolio. In more technical terms, it represents the component of a stock's return that is not correlated with general market moves. Modern portfolio theory shows that specific risk can be removed...
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...Financial Theories Overview Edward E. Edgar University of Phoenix Financial Theories Overview The following is an overview of 10 different financial theories prevalent today. The overview will include a brief description of the theory, an example of the theory, and other attributes of the theory. There will also be a conclusion to sum up a general understanding of the theories and their applications. Efficiency theory Efficiency theory has been around since the 60s and, is an extension of the efficiency theory of a capitalist society. Generally the theory is that scant resources are distributed by the owner in an efficient manner. The owner choses the best outcome for his or her investment and regulates resources and products accordingly. This is extended to the stock market in the 60s and has been a prevalent theory since. The theory as applied to the stock market says that all information of the market is fully reflected in the price of the stock and efficiently assimilated (Fama, 1970). Examples Generally stock returns are compared to overall market returns. A mutual fund company will compare their returns to the general stock market return and state they are a certain percentage above or below the market standard returns. Most will try to say they have beaten the market average. This is true for most investing firms and, is used as a selling point for the company or mutual fund. Attributes If this theory was to be taken to the extreme one would have to say that...
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...(PVA) o Amortization o Future value of an annuity (FVA) o Annuity due o Annual percentage rate (APR) • Ch. 7 o Total holding period return o Expected return o Variance (σ2) o Standard deviation (σ) o Normal distribution o Portfolio o Diversification o Coefficient of variation (CV) o Covariance o Diversifiable and nondiversifiable risk o Market portfolio o Market risk o Beta (β) o Capital asset pricing model (CAPM) o Security market line (SML) • Ch. 8 o Coupon payments o Face value or par value o Coupon rate o Opportunity cost o Par value bonds o Discount bonds o Premium bonds o Yield to maturity o Effective annual rate (EAY) o Realized yield o Interest rate risk o Yield curve • Ch. 9 o Bid price o Offer (ask) price o Dividend yield o Common stock o Preferred stock Content Overview • Time value of money o Single sums • Calculate present value. • Calculate periods. • Calculate interest and discount rate. • Calculate future value. • Interpret and make decisions from the calculations. • Understand the relationship between time, rate, and value. o Annuities • Identify various forms of annuities. • Calculate present...
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...Copyright : All rights reserved. No part of this course may be reproduced in any form by any means without prior permission in writing from: 0 BUSINESS FINANCE OUbs002223 January 2014 OUbs002223 Business Finance Table of Contents Unit 1 Agency Issue between shareholders and managers Unit 2 Investment appraisal methods Unit 3 Risks and Return Unit 4 Asset Pricing Models, CAPM & APT Unit 5 Capital Market Efficiency and Stock Market Anomalies Unit 6 Cost of Capital, Shareholder’s wealth, Gearing & Leasing Unit 7 The dividend decision Unit 8 Corporate Restructuring 1 Aim of the Module To provide learners with knowledge of the principles and practice of the financing decisions of enterprises. Learners will learn about the decisions which firms make about financing their investments in productive capital. Teaching and learning strategy The teaching and learning strategy is designed to develop in students an ability to understand the mechanisms of financial markets and the issues pertaining to investment decision in those markets. Students should be able to understand and apply the time value concepts with regards to investment decision. They should also be able to evaluate the risks and returns of financial instruments. Assessment Strategy Unit(s) of Assessment Assignment WrittenExamination Weighting Towards Module Mark (%) 30 70 GUIDELINES FOR SELFSTUDY ...
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...consumption pattern, demand for financial commodities arises. In this case assets held by the consumers serve as a possibility to rearrange their intra- and intertemporal consumption pattern for maximizing their utility. This leads to two key facts. First, utility is based on consumption at different points in time and second, transaction costs occur by acquiring financial commodities. Accordingly, financial intermediaries are able to facilitate intra- and inter-temporal consumption decisions due to a reduction of transaction costs. In this context reduction of transaction costs is seen as their central task. Concerning the inter- and intra-temporal demand for consumption it is necessary to take a look at the capital asset pricing model (CAPM), which...
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... 4. Capital Asset Pricing Model 4 5.1 Limitations of CAPM 4 5.2 The APT Model 4 5.3 The Three-Factor Model 4 5.4 Required Rate of Return using APT or Three-Factor 5 Model 5. Bonds 5 6.5 How bond prices are determined 5 6.6 The Rate of Return on the bonds 6 6. Conclusion 7. Appendices 6.1 Appendix 1 – after tax rate of return on bonds 7 6.2 Appendix 2 – Excel Working and screen shot 8. References 9. Bibliography 1. Introduction Naturally Fresh Plc are considering converting a number of their farms in Southern Europe into campsites following difficult trading conditions. This report will look at the required rate of returns on the equity as well as the bonds, whilst explaining the models used to calculate the returns and also provide a recommendation on whether the investment opportunity should be accepted by Naturally Fresh Plc. 2. Required Rate of Return on Equity Key | | E(R) | Expected/Required Rate of Return | R(f) | Risk Free Rate | B | Beta | R(m) | Market Return | R(m)-R(f) | Market Premium | Capital Asset Pricing Model (CAPM): E(R) = Rf + B(Rm-Rf) E(R) = 2% + 0.8(12%-2%) E(R) = 10% The required rate of return, which is the minimum yield that investors require in order to select a particular investment, was calculated using the CAPM. The CAPM is a model that describes the relationship between risk and return and...
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...CHAPTER 12: COST OF CAPITAL A. OVERVIEW Definition: Cost of capital refers to the rate of return • a firm must earn on its investment projects to increase the market value of its common shares • required by market suppliers of capital to attract funds to the firm Notes: • If project rate of return > cost of capital ( value of firm increases • If project rate of return < cost of capital ( value of firm decreases • Goal: minimize cost of capital Assumptions: 1. Business risk (not able to cover operating costs) is unchanged 2. Financial risk (not able to cover financial obligations) is unchanged 3. Cost of capital is measured on an after-tax basis Basic equation: Ways to evaluate the basic equation: 1. Time-series: historic cost of capital 2. Compare with other firms (cross-section) Example 1 (Time-series) Firm A had a cost of long-term debt 2 years ago of 8%. Risk-free cost of long-term debt is 4%. Business risk premium is 2%, and financial risk premium is 2%. What is the cost of long-term capital of the firm when the current risk-free cost of long-term debt is 6%? Example 2 (Cross-section comparison) Firm B is in the same business and with a financial premium of 4%. The cost of capital of firm B is higher than that of firm A by 2 %. Definition: Target capital structure refers to the desired optimal mix of debt and equity financing that most firms attempt to achieve and maintain. B. COST OF LONG-TERM DEBT ...
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...MODERN PORTFOLIO THEORY A N D INVESTMENT ANALYSIS EIGHTH EDITION INTERNATIONAL STUDENT VERSION EDWIN J. ELTON Leonard N. Stern School of Business New York University MARTIN J. GRUBER Leonard N. Stern School of Business New York University STEPHEN J. BROWN Leonard N. Stern School of Business New York University WILLIAM N. GOETZMANN Yale University WILEY John Wiley & Sons, Inc. Contents About the Authors Preface Part 1 Chapter 1 ix vii INTRODUCTION INTRODUCTION Outline of the Book 2 The Economic Theory of Choice: An Illustration Under Certainty Conclusion 8 Multiple Assets and Risk 8 Questions and Problems 9 Bibliography 10 4 1 2 Chapter 2 FINANCIAL MARKETS Trading Mechanics 11 Margin 14 Markets 18 Trade Types and Costs 25 Conclusion 27 Bibliography 27 1 1 Chapter 3 FINANCIAL SECURITIES Types of Marketable Financial Securities 2 8 The Return Characteristics of Alternative Security Types Stock Market Indexes 3 8 Bond Market Indexes 3 9 Conclusion 4 0 36 28 Part 2 Section I Chapter 4 P O R T F O L I O ANALYSIS MEAN VARIANCE PORTFOLIO THEORY THE CHARACTERISTICS OF THE OPPORTUNITY SET UNDER RISK Determining the Average Outcome 4 5 A Measure of Dispersion 4 6 Variance of Combinations of Assets 4 9 Characteristics of Portfolios in General 51 Two Concluding Examples 61 Conclusion 6 4 XIII 41 43 44 XIV CONTENTS Questions and Problems Bibliography 6 6 Chapter 5 64 DELINEATING EFFICIENT PORTFOLIOS Combinations...
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...Corporate Evaluation of Philip Morris International Study Programme Master of Business Administration (MBA) Module: Assignment: Course Instructor: Financial Management No 1/1 Authors: Student ID Number: 1st Academic Semester 2013 Place, Date Dortmund, 28th February 2014 Corporate Evaluation of Philip Morris International I Executive Summary The task of this assignment was to evaluate a company (if possible, listed) by two different evaluation methods: DCF method and multiplier method. The DCF analysis is divided into two separate evaluations: DCF entity method (WACC) and DCF equity method. In addition to calculating a corresponding theoretical foundation as well as a critical analysis of assessment methods / results was expected. Philip Morris International, as one of the biggest cigarette sellers of the world, is evaluated in this assignment to date of 31st December 2012. During evaluation by multiplier method the multipliers “price-earnings-ratio” and “market capitalization / EBITDA” were chosen and as peer companies British American Tobacco p.l.c., Imperial Tobacco Group p.l.c. and Japan Tobacco Inc. were used. The result of Philip Morris International evaluation by multiplier method is a value between $111 billion and $160 billion. The theoretical analysis of the different evaluation methodologies indicated that an evaluation by multiplier method can only give a rough guidance of the real corporate value. The evaluation by DCF method result...
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...Corporate Finance Fundamentals [FN1] Examination Blueprint 2010–2011 Purpose The Corporate Finance Fundamentals [FN1] examination has been constructed using an examination blueprint. The blueprint, also referred to as the test specifications, outlines the content areas covered on the examination and the weighting allotted to each content area. This document also lists the topics, the level of competence for each topic, and the related learning objectives. The learning objectives have been designed to ensure that the competencies are met. In addition, information is provided on the proportion of each question type presented in the examination (that is, multiple choice, quantitative problems, and so on). Use Students should use the examination blueprint to prepare for the course examination. The blueprint may not include all the topics listed in the course outline; however, students are still responsible for acquiring a broad-based knowledge of all topics not listed in the blueprint since these topics will be tested in assignment and review questions. The topics not listed in the blueprint will also provide students with a greater depth of understanding of finance concepts. Examination Objectives The objectives of this 3-hour, comprehensive examination are to test CGA students on the prerequisite knowledge required for the completion of Accounting Business Case [BC1] and advancement into Financial Accounting Consolidations and Advanced Issues [FA4], Accounting Theory and Contemporary...
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...I. INTRODUCTION: Midland Energy Resources was a global corporation specialising in oil and gas exploration and production (E&P), refining and marketing (R&M), and petrochemicals. Being one of the largest energy corporations in the world with a number of divisions, it is essential for the board of directors to calculate the company’s cost of capital accurately in order to apply it into several vital analyses of the corporation. This paper aims to estimate the corporate and divisional cost of capital for the next fiscal year and along with the estimations, several assumptions and arguments will be discussed to provide better overview and understanding of the whole process to the managers. II. INTRODUCTION TO WEIGHT AVERAGE COST OF CAPITAL (WACC): WACC is the weight average of the expected after-tax rates of return for all firm’s various sources of capital (Sheridan, 2011). In Midland, WACC is considered as the market-based weight average of the after-tax cost of debt and cost of equity: Estimation of WACC was used in many researches and analyses within Midland, including asset appraisals for capital budgeting and financial accounting, stock repurchase decisions, performance assessments, and project valuations. The above estimation of WACC requires the calculations of its three components: the cost of equity, the after-tax cost of debt and the firm’s target capital structure. Since changes in these above anticipated uses may affect the corporate target capital...
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...1.1 Shareholder analysis Group Limited (TGR) is the leader of producing Atlantic salmon in Australia. TGR was founded in 1986 and become public company listed on the ASX in 2003(Tassal 2014). In 2012, TGR formed partnership with the World Wide Fund and Nature Australia (WWF). TGR’s efforts in food safety, social welfare, animal welfare and, environmental and traceability aspects of the operations has earned itself the first company to achieve Best Aquaculture Practices (BAP) certification at farm level from Global Aquaculture Alliance (Sustainable Aquaculture 2014). TGR is making effort to excel in its management without ignoring its principles regarding quality, community and the environment. While producing superior salmon, TGR still prioritize customer needs by assuring them the food are safe for consumption. Hatching, farming processing , sales and marketing are the main business activities of TGR in Tasmanian Atlantic Salmon. TGR has made a in-depth research regarding the ethical aspects of fish farming, involving the feasible effects of antibiotics on consumers. Besides that, TGR is the retailer and wholesaler who offers different range of Atlantic salmon to the market. Their salmon comes in fresh, smoked, frozen, canned, hot smoked and small good ranges. These products are bought by Woolworth and Coles supermarket. According to the TGR's annual report 2013, the chairman and chief executive officer of the TGR had delivered the message to shareholders regarding the...
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...Team Members gazal gupta Varun Bansal TABLE OF CONTENTS * OVERVIEW * CALCULATIONS * WORKING * CONCLUSION Consumer Durables Overview of India’s Consumer Durables Market The Indian consumer durables segment can be segregated into consumer electronics (TVs, VCD players and audio systems etc.) and consumer appliances (also known as white goods) like refrigerators, washing machines, air conditioners (A/Cs), microwave ovens, vacuum cleaners and dishwashers. Most of the segments in this sector are characterized by intense competition, emergence of new companies (especially MNCs) and introduction of state-of-the-art models, price discounts and exchange schemes. MNCs continue to dominate the Indian consumer durable segment, which is apparent from the fact that these companies command more than 65 per cent market share in the colour television (CTV) segment. In consonance with the global trend, over the years, demand for consumer durables has increased with rising income levels, double-income families, changing lifestyles, availability of credit, increasing consumer awareness and introduction of new models. Products like air conditioners are no longer perceived as luxury products. Companies under Evaluation:- * Bajaj Electricals * HCL info Systems ltd * TTK Prestige Ltd * Value Industries Ltd * Voltas Ltd Calculations Calculation of Cost of equity using CAPM approach K=Rf + β (Rm- Rf) K= Cost of Equity Rf = Risk free rate...
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...3.0.1 International Business - University Assessment 100 Marks Course Content 1. Overview of the International Business Process 2. PEST factors affecting International Business 3. Government influence on trade 4. International Trade Theories 5. FDI 6. Country Evaluation and Selection 7. Collaborative Strategies 8. International Marketing 9. International Trade Agreements 10. International Trade Organizations 11. International HR Strategies . 12. International Diplomacy - . Reference Text 1. International Business - Daniels and Radebouqh 2. International Business - Sundaram and Black 3. International Business — Roebuck and Simon 4. International Business – Charles Hill 5. International Business— Subba Rao 3.0.2 Strategic management 100 Marks Course Content 1. Strategic Management Process: Vision. Mission, Goal Philosophy. Policies of an Organization. 2. Strategy, Strategy as planned action, Its importance, Process and advantages of planning Strategic v/s Operational Planning. 3. Decision making and problem solving. Categories of problems, Problem solving skill, Group decision making. Phases indecision making, 4. Communication Commitment and performance, Role of the leader, Manager v/s Leaders Leadership styles 5. Conventional Strategic Management v[s Unconventional Strategic Management. The Differences, Changed Circumstance. 6. Growth...
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...Company Analysis – Bank of America Corporation FIN300: Financial Management Professors Name NAME University February 27th, 2015 NAME Company Overview Bank of American Corporation is currently one of the largest banks in the US. It currently holds the 3rd largest bank place in deposits right after JP Morgan and Wells Fargo. It has locations from coast to coast and has been in business since 1904. Bank of America was funded in 1998, however before that it was called Bank of Italy. It is headquartered in Charlotte, North Carolina. Currently is ran under the leadership of Brian Moynihan, CEO. Bank of America offers a large array of financial solutions including retail banking, home lending, investments, wealth management, business lending, consumer lending, private banking and corporate banking. A couple of large institutions Bank of America acquired in the recent years are: Nations Bank and Countrywide. Its investment partner is Merrill Lynch. It currently trades by BAC at the New York Stock Exchange (NYSE). The current stock rate for BAC is $15.81. Stocks for BAC dropped just like it did for most banks in 2010. At one point it was around $5 a share. However, they have stabilized their stock specially by controlling their mortgage loans going in default, which was an issue acquired from the acquisition of Countrywide, and since then their stock have been consistently going up with an estimated end of year at $18.5 a share. Below is provided a copy of their last year...
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