Capital Asset Pricing Model

CAPM tells how assets should be priced in capital markets

Investors Borrow or Lend Funds at a riskless rate. single person cannot influence Market.CAPM Assumptions • • • • • Investors decisions are based on Risk and Return relationship. Investors can short sell Shares. Perfect competition exists in market viz. . Investors have identical expectations.

no cost involved in buying and selling of stocks. • There is no personal income tax or Capital Gains Tax Rate = Dividends Tax Rate . • There is no transaction cost i.CAPM • Investors are assumed to have homogenous expectations during the decision making period.e. • Assets are infinitely divisible.

Xf =Proportion of funds invested in risky assets Rf = Risk free rate of return Rm = Return of risky assets . Rp = Portfolio return Xf = Proportion of funds invested in risk free assets 1.CAPM If investors could borrow or lend any amount of money at risk-less rate of interest they can combine risk free assets with the risky assets in a portfolio to obtain a desired rate of risk-return combination.

Xf ) .CAPM The Model Rp = Rf Xf + Rm (1.

CAPM Rp Rp CML C B S Rf 0 A σp 0 σp Capital Market Line(CML) Efficient Frontier .

CAPM Ex-Ante RP derived E(Rp) = Rf + (Rm – Rf ) σm σp E(Rp) = portfolio’s expected rate of return Rm = expected return on market portfolio σm = standard deviation of market portfolio σp = standard deviation of the portfolio .

Security Market Line R i – Rf = COVim [Rm – Rf] σ2m E(Ri) = Rf + βi[E(Rm) .Rf ] .

SML Y Rp SML Rm Rf Beta X S 1 .

2 X .Po + Div Ri = Po SML Rf 0 1.1 Beta 1.0 T x C x x W Pi .9 S x B x x V 1.SML & Securities Evaluation Rp R x A x x U 0.

Sign up to vote on this title
UsefulNot useful