Capital Asset Pricing Model: Meaning and Assumptions Management YouTube Lecture Handouts

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Capital Asset Pricing Model Pricing and Assumptions - Meaning, Assumption, Formula|Management

Title: Capital Asset Pricing Model: Meaning and Assumptions

Meaning

  • CAPM is used to show the relationship between the expected return and risk in a security.
  • It was introduced by Jack Treynor, William Sharpe and John Litner.
  • Elements like Beta or systematic risk are used to measure the risk in a security.

Assumptions

  • All investors are averse to the risk.
  • The amount of available assets is fixed during a given time.
  • Markets are ideal i.e.. , there is not transaction cost, taxes, inflation or short selling restriction.
  • Investors hold diversified portfolios. Hence, there is no unsystematic risk.
  • Markets are highly efficient. All investors have equal access to all the information.
  • Beta coefficient is the only measure of the risk.
  • All assets are absolutely liquid and infinitely divided.
  • Markets are in equilibrium; All investors are price takers not makers.

Concept of Security Market Line

Illustration: Concept of Security Market Line

It shows the graphical representation of the CAPM

Formula

  • Ra = Rf + Ba + (Rm-Rf)
  • Ra = Expected return on a security
  • Rf = Risk free rate
  • Rm = Expected return of the market
  • Ba = Beta of a security

MCQs

The other name of Beta is?

A. Unsystematic risk

B. Market risk

C. Systematic risk

D. None of the above

Answer: C

What does Rf represent in CAPM formula?

A. Risk rate

B. Risk free rate

C. CAPM

D. SML

Answer: B

Manishika