Capital asset pricing model

Ahmed T.

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Capital asset pricing model

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Abstract

Capital Asset Pricing Model is a tool to calculate the required rate of return for a security. It takes into account the return that an investor can earn on risk free security (usually government T-Bills), risk premium (difference between the return on risk free investment and return on investment in market) and beta. Beta is a measure that is used to calculate the overall risk position of a company against the risk condition of the market. If the value of beta is greater than one, the stock is more risky as compared to the market. If the value of beta is less than one, then the stock is less risky as compared to the market. Capital Asset Pricing Model can be thought of as a system that takes the several market conditions as input and gives the rate of return than an investor should demand on a particular stock as an output.

However, the modern financial gurus believe that the CAPM theory has become redundant and superfluous. Since the CAPM assumes that there are no other costs associated with the investment in a company, therefore the answer given by this model is of little use. However, there are several other reasons which have made this model redundant and these reasons are discussed in the next few paragraphs. (Fama and French, 2006 pp. 2163-2185)

Introduction
Capital asset pricing model tool
Models of financial investments
Conclusion

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[...] Investopedia.com (2008) Measure Your Portfolio's Performance. [online] Available at: http://www.investopedia.com/articles/08/performance- measure.asp#axzz1qQf7RXcW [Accessed: 28 Mar 2012]. Investopedia.com (1952) Capital Asset Pricing Model (CAPM) Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/c/capm.asp [Accessed: 19 Apr 2012]. Koster, J. (2010) Value Investing World: Another good debunking of the efficient market theory, CAPM, and the use of beta to measure risk. [online] Available at: http://www.valueinvestingworld.com/2010/04/another- good-debunking-of-efficient.html [Accessed: 19 Apr 2012]. McAdams, L. and Karagiannis, E. (1994) Using Yield Curve Shapes to Manage Bond Portfolios. CFA Institute, 50 (3), p.57-60. [...]

[...] Capital asset pricing model Capital Asset Pricing Model is a tool to calculate the required rate of return for a security. It takes into account the return that an investor can earn on risk free security (usually government T-Bills), risk premium (difference between the return on risk free investment and return on investment in market) and beta. Beta is a measure that is used to calculate the overall risk position of a company against the risk condition of the market. [...]

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