Question

4. What are the assumptions of the 2 following models:

CAPM:

Dividend discount model:

Answer 1

Capm model:The model emphasises the risk factor in portfolio theory which is a combination of two risks, systematic risk and unsystematic risk.

Assumption

It's assumption references is of 2 type

1-with reference to investor

2-with reference to market

1- with reference to investor

-Their objective is to maximize the utility of terminal wealth.

-Investment goals of investors are rational. They desire higher return for any acceptable level of risk and lower risk for any desired level of return.

-Their choice is based on the risk and return of a security.

-They have homogenous expectations of Risk and Return over an identical time horizon

2.with reference to market

-No taxes, transaction costs, restrictions on short-term rates or other market imperfections.

-Total asset quantity is fixed, and all assets are marketable and divisible.

-Information is freely and simultaneously available to all investors.

-Capital Market is not dominated by any individual investors.

- Investors can borrow and lend unlimited amount at the risk-free rate.

Assumption of dividend discount model

The dividend discount model was developed under the assumption that the intrinsic value of a stock reflects the present value of all future cash flows generated by a security. At the same time, dividends are essentially the positive cash flows generated by a company and distributed to the shareholders.