(e) Briefly discuss the implications of the Capital Asset Pricing Model for the relationship between the...

(e) Briefly discuss the implications of the Capital Asset Pricing Model for the relationship between the current spot price of an asset and the discount offered by the seller of a futures contract.

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ANS:

CAPM (Capital asset pricing model) describes the relationship between systematic risk & expected return for assets.

Cost of equity (Ke) is calculated by CAPM = Risk free rate (Rf) + Beta (Market return - Risk free rate)

Ke calculated via CAPM has relationship Spot price which is established with the help of following formula -

Spot price (Po) = Do * (1+g) / Ke -g

Therefore, there is an inverse relationship between Price & Ke. Spot price are the immediate buying & selling price, i.e Spot price is the current price at which stock, commodity or currency can be bought or sold. On the other hand, when spot price exceeds the future price, it is referred as discount, it means there is favourable situation for investors to invest & earn a good return. Basically Premium & Discount in stock market depends upon the following points -

Economic Strenght of Industry
Liquidity in stock market
Marketing Trends
Inflation / Deflation in market etc.

jeff jeffy answered 1 year ago

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