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Capital asset pricing model essay
The Capital Asset Pricing Model Intercontinental
The Capital Asset Pricing Model Intercontinental
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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. Figure 2 shows the APT formula. Figure 2 CAPM- Strength CAPM includes systematic risks in its calculations. Systematic risks are risks that are caused by macroeconomic factors like war, recession, inflation, interest …show more content…
Assume 2 investors, Mr. A holding a portfolio of β > 1 and Mr. B, holding a portfolio of β < 1. Mr. A would have a greater impact on his returns during The Great Recession than Mr. B. However, if Mr. A had used the CAPM model and recognised that his portfolio is a volatile one, he would have demanded for high returns. Hence the high returns earned prior to The Great Depression would compensate for the loss suffered during the recession. CAPM - WEAKNESSES The assumptions for this model is listed in Appendix 1. The following discussion is based on these assumptions. The CAPM assumes that there are unlimited short sales in the investment universe. The U.S. Securities and Commission defines short sales as “sale of a stock you do not own”. However this assumption does not entirely hold in today’s world. According to the U.S. Securities and Commission “it is prohibited for any person to engage in a series of short sales transactions.” According to the Chartered Financial Analyst board, for the CAPM to be valid at least two of its key assumptions need to be true: “there are no restrictions on risk – free borrowing and/or no restrictions on short sales.” This clearly shows that the CAPM is no longer valid to be used in markets that have restrictions imposed on short – sales as the market portfolio can be inefficient and the relationship between …show more content…
This is indeed not true. A CEO of ExxonMobil would definitely have better information on ExxonMobil stocks than a doctor who holds ExxonMobil stocks. As a CEO the individual is exposed to internal information that would enable him to make better decisions on choosing stocks and taking precautionary steps. For example, in the recent oil price drop, the CEO of ExxonMobil would know that his stocks are getting riskier, even before Standard & Poor releases a statement to the general public - The Financial Times on 2/2/2015 “ExxonMobil’s triple-A rating under threat.” With different information available, different actions will be taken, thus not all investors will be holding identical portfolios anymore. This causes another assumption, investors have homogenous expectations, to be rejected in this real
outline causes leading up to 1929 stock market crash - policy implementations to fix those errors then compare to rise of great depression in 2008. there are similarities and differences in focus when analyzing these two large crisis. explain lessons learned from both eras and raise main points
The stock market crash of 1929 is one of the main causes of the Great Depression. Before the stock market crash many people bought on margin, which caused the stock market to become very unbalanced, which led to the crash. Many people had invested heavily in the stock market during the 1920’s. All of these people who invested in the stock market lost all the money they had, since they relied on the stock market so much. The stock market crash also played a more physiological role in causing the Great depression. More businesses became aware of the difficulties, which caused businesses to not expand and start new projects. This caused job insecurity and uncertainty in incomes for employees. The crash was also used as a symbol of the changing times. The crash lead the American peop...
The stock market crash of 1929 is the primary event that led to the collapse of stability in the nation and ultimately paved the road to the Great Depression. The crash was a wide range of causes that varied throughout the prosperous times of the 1920’s. There were consumers buying on margin, too much faith in businesses and government, and most felt there were large expansions in the stock market. Because of all these...
The stock market crash had a colossal contribution to the Great Depression. The stock market crash rolled in after the golden time in the 1920’s; with it came the Great Depression trailing right behind. The stock market crash was caused by people investing in stocks with money they did not have, this was called buying on margin. When the stocks fell everyone lost an enormous amount of money that they had invested into the stocks. The stock market was the main cause that forced American into the Great Depression. The stocks were a towering success until the collapse; the crash forced many Americans into poverty because they had to sell almost everything they had to repa...
The estimates of cost of capital for equity 6.14% are making by using the capital asset pricing model (CAPM) to generate forecast of DDM and RIM. This method is defined by the sum of risk free rate plus beta that multiplied with a risk premium. Particularly, the beta, which is a quantitative measure of the volatility of company stock relative to the unstable of the overall market, found in JB HI-FI case at 0.56 (JB HI-FI financial statement 2016). It
Regardless, in regards to applying Keynesian economic policies toward the Great Depression, Former Federal Reserve Governor Ben S. Bernanke said “You 're right, we did it. We 're very sorry. … we won 't do it again” (Federal Reserve Board, 2002). Other economic theory must be developed to address some of the shortcomings of the Keynesian economic
In conclusion table 10-1 on page 292 list the three types of models. These models provide
There is no doubt that the stock market crash contributed to the great depression, but how? One way that the Crash contributed to the depression was the loss of money it caused to the average man. It is believed that in the first day of the crash almost a billion dollars were lost, this took a large amount out of the pocket of the common man. Without this money people were unable to purchase consumer goods, which the United States economy was based on. Another way the Crash contributed to the depression was the loss of confidence in the market. When t...
The stock market crash is debatable on how much it affected the Great Depression. Many economists disagree on how much the stock market crash affected the depression. Milton Friedman states "The stock market crash in 1929 played a role in the initial depression. " This can King 2 conclude that the crash was not the sole cause of the depression. It changed the expectations of the future from once a positive view to a negative view.
The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.
This assignment is concerned with your understanding of the key issues relative to portfolio analysis and investment. In completing this assignment you are to limit your scope to the US stock markets only. Use the Cybrary, the Internet, and course resources to write a 2-page essay which you will use with new clients of your financial planning business which addresses the following issues and/or practices:
According to Perold (2004), ‘CAPM can be served as a benchmark for understanding the capital market phenomena that cause asset prices and investor behavior to deviate from the prescript...
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. This paper discusses the importance of asset allocation, the differences and the proper diversification within the portfolio.
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
The Modern portfolio theory {MPT}, "proposes how rational investors will use diversification to optimize their portfolios, and how an asset should be priced given its risk relative to the market as a whole. The basic concepts of the theory are the efficient frontier, Capital Asset Pricing Model and beta coefficient, the Capital Market Line and the Securities Market Line. MPT models the return of an asset as a random variable and a portfolio as a weighted combination of assets; the return of a portfolio is thus also a random variable and consequently has an expected value and a variance.