Group No: 16

CAPITAL ASSETS PRICING MODEL

(CAPM)

PRESENTED BY:

Sushant Bakhla
Vivek Kumar
Ravi Kumar
Mohit Walter
Raushan Kumar
Shubham Prakash

105
107
108
109
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112

CONTENTS

CAPM
TYPES OF RISK
ASSUMPTIONS
SECURITY MARKET LINE
DRAWBACKS
BETA
IMPLICATIONS
AND
RELEVANCE
CAPM
THE ARBITRAGE PRICING THEORY

OF

CAPITAL ASSET PRICING MODEL (CAPM)

The capital asset pricing model (CAPM) is a

model that provides a framework to
determine the required rate of return on an
asset and indicates the relationship between
return and risk of the asset.
The required rate of return specified by
CAPM helps in valuing an asset.

TYPES OF RISK

Systematic Risk
Unsystematic Risk

CAPM EQUATION

E(ri) = Rf + i(E(rm) - Rf )

E(ri) = return required on financial asset i

Rf = risk-free rate of return

i = beta value for financial asset i

E(rm) = average return on the capital market

ADVANTAGES

Ease-of-use
Diversified Portfolio
Systematic Risk(beta)
Business andFinancial
RiskVariability

ASSUMPTIONS OF CAPM
Market
Market efficiency
efficiency
Risk
Risk aversion
aversion and
and mean-variance
mean-variance
optimization
optimization
Homogeneous
Homogeneous expectations
expectations
Single
Single time
time period
period
Risk-free
Risk-free rate
rate

DRAWBACKS OF CAPM

Risk-free Rate (Rf)

Return on the Market (Rm)
Ability to Borrow at a Risk-free
Rate
Determination
of
Project
Proxy Beta

BETA

A measure of the volatility, or

systematic risk, of a security or a
portfolio in comparison to the
market as a whole.

IMPLICATIONS AND RELEVANCE

OF CAPM

IMPLICATIONS

Investors will always combine a risk-free

asset with a market portfolio of risky
assets.

Investors will be compensated only for

that risk which they cannot diversify.

Investors can expect returns from their

investment according to the risk.

LIMITATIONS

It is based on unrealistic assumptions.

It is difficult to test the validity of
CAPM.
Betas do not remain stable over time.

THE ARBITRAGE PRICING THEORY (APT)

The act of taking advantage of a price differential

between two or more markets is referred to as
arbitrage.
The Arbitrage Pricing Theory (APT) describes the
method of bring a mispriced asset in line with its
expected price.
An asset is considered mispriced if its current price is
different from the predicted price as per the model.
The fundamental logic of APT is that investors always
indulge in arbitrage whenever they find differences in
the returns of assets with similar risk characteristics.

CONCEPT OF RETURN UNDER

APT

CONCEPT OF RISK UNDER APT

STEPS IN CALCULATING
EXPECTED RETURN UNDER APT
Searching for the factors that
affect the Assets return
Estimation of risk premium for
each factor
Estimation of factor Beta

C0NCLUSION

Research has shown the CAPM to stand

up well to criticism, although attacks
against it have been increasing in
recent years. Until something better
presents itself, however, the CAPM
remains a very useful item in the
financial management toolkit.