Essay on CAPM Model

Essay on CAPM Model

Length: 1835 words (5.2 double-spaced pages)

Rating: Strong Essays

Open Document

Essay Preview

Correlation coefficient is “a standardized measure of the relationship between two variables that ranges from -1.00 to +1.00. (Brown and Reilly, 2009, p1016) It is a statistical concept.
a) At the first occasion, I have to refer in two assets which have a high positive Correlation. In other words, if an upward (increasing) or downward (decreasing) movement in one asset tends to be accompanied by an upward or downward shift to the other asset as well. For instance, FTSE100 has a high positive Correlation with FTSE350. According to Levy, H. and Post, T. (2005) the correlation between these two indices is 0.95 (p.194). This occurs due to the fact that these two assets are from the same market sector. In addition, 100 of the 350 stocks are the same. Hence, if there is a significant rise or reduction at the price of bonds for FTSE100, the same shifts they will occur for FTSE350 bonds as well. Due to this fact, the correlation coefficient is definitely high.
b) On the other hand, when an upward or downward movement in one stock tends to be followed by a slightly upward or downward shift in other stock, is referred that they have positive low Correlation. For instance, Barclays and O2 are two companies which I personally believe that they have positive low Correlation. First of all, my opinion is based to the fact that Barclays is a bank company and O2 is a telecommunications company. Therefore, they are two companies which belong into two different market sectors, they are non-competitive companies. As a result, the coefficient correlation between these two businesses is low positive correlation. According to Levy, H. and Post, T. (2005) mean-variance theory is “evaluation of investment strategies based on the exp...


... middle of paper ...


...rstand. They try to follow an index –typically the FTSE All-Share or FTSE 100—which measures the performance of all or part of the stock market. If the market does well, the tracker does well. If it does badly the tracker does badly”. (p.386). In other words, it is a collective investment way to follow the performance of a specific index. In addition, the most important advantage of these funds is that are cheap due to the fact that they just do what the market does and the managers do not have to invest at any big bets to outperform them. Moreover, I personally believe that “Index Tracker Funds” are appropriate assets for those who believe that CAPM and its assumptions are correct.



d) Nowadays, is generally consider that CAPM model has some disadvantages and limitations, hence for investors it might be an unsatisfactory model.





Need Writing Help?

Get feedback on grammar, clarity, concision and logic instantly.

Check your paper »

Essay on Capital Asset Pricing Model ( Capm )

- Security market line (SML) is a line on a chart representing the capital asset pricing model (CAPM). The security market line plots risk versus expected return of the market. The security market line is a useful tool in determining the relationship between risk and return for individual securities. If a security plots the security market line, it indicates a higher expected return for a given level of risk than the market. The security market line shows a positive linear relationship between returns and systematic risk as measured by beta (Boundless, 2016, para.2)....   [tags: Capital asset pricing model, Financial markets]

Strong Essays
933 words (2.7 pages)

Capm Model : The Beta, Risk Free Rate And The Expected Market Risk Premium

- CAPM model requir the beta, risk-free rate and the expected market risk premium to calculate expected rate of return of the security. From the graph above, it can be seen that, CAPM model has a direct relationship with the capital market line, which is a straight line connecting risk-free assets with the market portfolio. If the market equilibrium exists, all asset prices will be automatically adjusted until it all can be accepted by the investor. In the CAPM formula, “r” is expected return on sercurity, “”rf ” is risk-free rate, “rm” is the return from the market....   [tags: Capital asset pricing model, Financial markets]

Strong Essays
978 words (2.8 pages)

Essay on CAPM Model

- Correlation coefficient is “a standardized measure of the relationship between two variables that ranges from -1.00 to +1.00. (Brown and Reilly, 2009, p1016) It is a statistical concept. a) At the first occasion, I have to refer in two assets which have a high positive Correlation. In other words, if an upward (increasing) or downward (decreasing) movement in one asset tends to be accompanied by an upward or downward shift to the other asset as well. For instance, FTSE100 has a high positive Correlation with FTSE350....   [tags: Financial Analysis]

Strong Essays
1835 words (5.2 pages)

Capital Asset Pricing Model ( Capm ) Essay

- There are a lot of items that go into buying and investing in a company. One of the hardest decisions for a shareholder is deciding if the investment is going to be profitable. Once a shareholder decides to buy or invest in an organization the next step would be deciding how much to pay or invest. Another hard decision is if the investment that was made goes bad can you get out of this obligation. Throughout the course of the paper I will illustrate some of the items that assist with this decision process....   [tags: Finance, Weighted average cost of capital]

Strong Essays
825 words (2.4 pages)

Capital Asset Pricing Model ( Capm ) And Arbitrage Pricing Theory Essay

- Introduction This report discusses about the strengths and weaknesses two types of asset pricing theory - Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT). The CAPM model shows the relationship between the fair expected returns and the systematic risk of a portfolio. Figure 1 shows the formula of CAPM. The APT model also shows the relationship between the fair expected returns and risk in line with the law of one price, taking into account both systematic and unsystematic risks....   [tags: Capital asset pricing model]

Strong Essays
707 words (2 pages)

Essay on Capital Asset Pricing Model ( Capm ), Arbitrage Pricing Theory

- In the following essay I will be comparing and contrasting the effectives of capital asset pricing model (CAPM), Arbitrage Pricing Theory, and the Fama-French three factor model when estimating the cost of capital and explaining performance of investment portfolios. Todays widely used CAPM model was originally developed by Sharpe (1964) in order to explain how capital markets set share prices. (Pike and Neale) However, was then developed by others such as Harry Markowitz, John Linter and Jack Treynor....   [tags: Capital asset pricing model, Financial markets]

Strong Essays
1608 words (4.6 pages)

Essay about The Capital Asset Pricing Model (CAPM)

- The Capital Asset Pricing Model (CAPM) Introduction In almost every economics textbook (Ben and Robert, 2001), economists tend to argue: everything’s market price is determined by consumers’ demand and supply in the market, the intersection of which gives us the long-term concept of ‘market equilibrium’. Although it sounds straightforward, it is anything but easy in practice, especially when the assets (like common stock) you are measuring associated with risk and future uncertainties. Fortunately, economists and financial analysts have developed plenty of theories to help us explain how the risk for market assets can be appropriately measured in our life....   [tags: Business Management Studies]

Strong Essays
1862 words (5.3 pages)

Capital Asset Pricing Model (CAPM) Essay

- The capital asset pricing model (CAPM) is a mathematical model that offers an explanation about the relationship between investment risk and return. By dividing the covariance of an asset's return by the variance of the market, an asset value can be determined. To ascertain the risk level of a particular asset, the market is evaluated as a whole. Unlike the DCF model, the time value of money is not considered. This model assumes the investors understands the risk involved and trades without cost....   [tags: Finance Analysis]

Free Essays
1006 words (2.9 pages)

Islamic Financing vs the Capital Asset Pricing Model (CAPM) Essay

- The research article discusses two approaches, one method is Islamic financing and other is the conventional capital asset pricing model (CAPM). Using the direct Musharakah, Islamic financing method is applied against the conventional financing method by comparing each other. Comparing the two approaches has drawn several findings; it is found that the beta-risk is lower on investments, which are based on the partnership of Islamic financing as compared to the conventional market. The risk is on the share of the lenders and others but not on the risk-return....   [tags: Islamic Finance Essays]

Strong Essays
2951 words (8.4 pages)

Application Of The Capm As A Tool For Regulators Essay

- A lot of regulation is concerned with a firm’s rate of return, and so early practitioners advocated the use of the CAPM as a tool for regulators in setting appropriate rates that allow firms within regulated industries (such as utilities) to earn a rate of return that is commensurate for firms with a similar degree of riskiness. The application of the CAPM has been demonstrated in two different papers both published in 2012. The first by Muradoglu and Sivaprasad (2012) uses the CAPM formula to look at gearing and its effects on stock returns to measurements of firm performance, as stock returns are forward-looking and they integrate expectations of investors of the future value of the firm....   [tags: Weighted average cost of capital, Finance]

Strong Essays
1249 words (3.6 pages)