Question

One of the most important financial models is the Capital Asset Pricing Model (CAMP). It basically says that the expected return of an asset is related to several factors such as the risk-free rate, the beta of the asset and the expected rate of return on the market portfolio.
For initial discussion post, choose a stock, and explain how you would come up with the expected rate of return for your stock based on the CAPM. When doing so, assume a reasonable risk-free rate, and the expected rate of the market portfolio, and you can find the beta of your stock in one of the financial.

How does one measure the beta for a stock? What does the beta of your stock say about your stock's risk? Do you think the expected return of your stock predicted by CAPM is a reasonable one? What assumptions of the CAPM make the prediction unstable or vulnerable?

Please be as elaborate as you can with numerical examples.

discussion post should consist of 250-300 words

MUST BE NEW

Answer 1

Answer:

Capital Asset Pricing Model:

Capital Asset pricing model basically says about expected return of an asset which is related to several factors such as risk free rate, beta of stock and expected rate of return on the market portfolio.

This model was developed by Financial economist William sharpe around 1970.

According to CAPM Model return of an individual stock or group of stocks is equal to its cost of capital. The basic formula of it describes the relationship between risk and market premium.

The formula of CAPM MODEL is as follows:

Re = Rrf + b *( Rm - Rrf )

Where, Re = Expected return on a security or stock

           Rrf = Risk free interest rate.

           Rm = Expected market return of stock

            b = Beta of the stock

           ( Rm - Rf ) = Equity market premium

According to Capm model beta(b) is a measure of a stock's risk volatility of return reflected by measuring the fluctuation of its price changes relative to the overall market.it is the stock's sensitivity to market risk. for instance if the beta of the company is 0.5,the stock has 50% of the volatility of the market average.if beta is equal to 1, then expected return on a stock is equal to the average market return.and the negative beta value is equal to showing of negative correlation with the market.

We can find out beta value of stock by using above formula if Re, Rm,and Rrf value are given. By puting these vaue in the equation or formula we can find the value of beta ( b).

Suppose Rrf = 10%, Rm= 5% and beta (b)= 2 , we can find Re

Re= Rrf + b( Rm - Rrf) = 0.1+ 2(5-10)= 0.1+ 2*-5 = 0.1+(-10%) =0

Assumption of Capm Model:

-Investors can sell short any number of shares without limit.

-The purchase and sell transaction can be undertaken in infinitely divisible units.

-There is perfect competition and no single investor can influence prices with no transaction costs, involved.

-Investors are expected to make decesion besed on solely on risk return assesment.

The expected return of stock calculated through Capm Model is a reasonable , it is widely used in finance.