Graham and Harvey surveyed the CFOs of 392 U.S. firms and found that when estimating the capital of assets,73.5% of respondents use the CAPM.( Graham, J. R., and C. R. Harvey,2001) It is a model which uses simple formula to evaluate asset pricing and investor behavior. This model is absolutely the method with most investors used, but many financial experts raise an objection to the veracity of this method in the recent years. Later in the main body of the essay will discuss these questions. In the first part of the essay will introduce the CAPM and the main factor of this method. Secondly, is the discussion of the uses and limits of the CAPM while evaluating the potential investment of a firm 's share. After that is the adverse and favorable way of the CAPM as a resource of discount rate. The last paragraph is the conclusion that rating the merits and demerits of the CAPM in the investment.
Capital asset pricing model (CAPM) first provide the coherent framework for answering the relationship of expected return and the risk of investments and how equilibrium price come out.(Perold, A. F. ,2004) The initial goal of CAPM is to assess the risky assets such as stock. And the stock value is mostly according to the degree of risk that the held shares might get the return. These properties are similar to venture capital and both of them discounted future earnings in accordance with risk premium. So that, CAPM can used to determine the discount rate of the venture investment project at the same time. Although the model does not describe the current world well, it still gives investors a prediction of their future behavior.
For investors, CAPM is a method to prescribe the expected r...
... middle of paper ...
...ts can reasonably be excluded from the market portfolio, and data availability substantially limits the assets that are included. As a result, tests of the CAPM are forced to use proxies for the market portfolio, in effect testing whether the proxies are on the minimum variance frontier. (Fama, E. F., & French, K. R. ,2004)
3. The present price trend is not a good guide for future tendency of price. Sometimes, some Technology stocks do not exist that long to estimate the future trend. Furthermore, the beta focus on single stock tends to change direction as time goes by, which makes it unauthentic in long-term horizon.
CAPM is not a perfect model, but it is correct from analysis the problem. It provides a model which can evaluate the degree of risk and this can help investors to make the decision whether it is worth to face the risk for its future return.
Need Writing Help?
Get feedback on grammar, clarity, concision and logic instantly.Check your paper »
- Introduction It was previously assumed that economic investors and regulators (agents) utilised all available information and thus market prices were a reflection of this information with assets representing their fundamental value, encouraging the position that agents’ actions were rational. The 2007-2008 Global Financial Crisis (GFC) is posited to have originated from the notion that all available information was utilised, causing agents to fail to thoroughly investigate and confirm “the true values of publicly traded securities,” leading to a failure to register the presence of an asset price bubble preceding the GFC (Ball 2009).... [tags: investors, regulators, human behavior, ]
909 words (2.6 pages)
- According to Investopedia (Asset Allocation Definition, 2013), asset allocation is an investment strategy that aims to balance risk and reward by distributing a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. There are three main asset classes: equities, fixed-income, cash and cash equivalents; but they all have different levels of risk and return. A prudent investor should be careful in allocating each asset class to his portfolio. Proper asset allocation is a highly debatable subject and is not designed equally for everybody, but is rather based on the desires and needs of the individual investor.... [tags: Asset Allocation Essays]
1614 words (4.6 pages)
- Asset Allocation Asset allocation is the process of deciding how to distribute an investor’s wealth among different countries and assets classes for investment purposes. An asset class is comprised of securities that have similar characteristics, attributes and risk/ return relationships. In other word, asset allocation defined as investing money or well diversified in different classes of assets, as stocks, bonds and money market funds. There are several risks that involve in asset allocation, such as liquidity needs, time horizon, tax concern, legal and regulatory factors and unique needs and preferences.... [tags: investor, wealth, risks]
1297 words (3.7 pages)
- 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]
933 words (2.7 pages)
- Introduction “According to Forrester Research, American workers spend $404 billion annually, or 11% of all U.S. wages, looking for the information they need to do their jobs. Giving employees the right tools to stay afloat in a data and knowledge-driven workplace is imperative across the board.” With the world of digital data growing exponentially year on year, the above quote could just represent a mere drop in the ocean when accounting for the time workers spend looking for information.... [tags: Digital Asset Management]
2896 words (8.3 pages)
- 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]
707 words (2 pages)
- 1. Please discuss and explain the CAPM and the SML. Provide a numerical example for the CAPM. Total risk is the relevant measure of risk, do you agree. The security market line (SML) is a line that charts the efficient, or market, risk versus return of the entire market at a specific time and demonstrates all risky marketable securities. The SML basically diagrams the outcomes from the capital asset pricing model (CAPM) recipe. The x-hub speaks to the risk (beta), and the y-hub speaks to the normal return.... [tags: Capital asset pricing model]
734 words (2.1 pages)
- Organizational Vision Plan for A Potential Investor Founded in 1999, Champion Broadband (Champion) provides advanced communications services to residential and business customers in Monrovia and Arcadia, California (CA). Champion offers digital telephone, high-speed Internet access and Digital TV over its technologically advanced IP-based network. As a leading provider of communications services, we have continually taken pride in connecting people and enriching their lives. Champion believes in the enduring and essential belief in integrity, service, collaboration, pride and people.... [tags: investor, Champion, plan]
745 words (2.1 pages)
- 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]
1608 words (4.6 pages)
- This essay will serve to introduce the topic of my Specialised Project and will highlight the structure that will be used to present its findings as well as briefly discuss the nature of each section and how it will relate to my final project. Given the subject matter of the dissertation it is apparent that a thesis is a suitable structure in which to explore the hypotheses that will be put forward. It will consist of a combination of theoretical and empirical research, i.e. based on observation and experiment.... [tags: Research Introduction]
2500 words (7.1 pages)