Question

2.  Stocks versus Gambling: Critically evaluate the following statement: playing the stock market is like gambling. Such speculative investing has no social value, other than the pleasure people get from this form of gambling. 3. Discuss the limitations and challenges of CAPM when you apply this model to the real world stock markets.

Answer 1

Answer(2): Against the gambling- No, Stock market investing in not Gambling, it is rather investing and trading in securities. Stock market is a platform where we can buy and sell shares online and get the profit. It provides chance to diversify our portfolio by buying number of stocks of different sectors.

In favor of gambling- It is gambling for those who are speculators, they trade on daily basis and buy the shares in large quantities and sell them $.50 or $1 up so that they can get profit, they trade very frequently in a day, some of the speculators are operators of the market. People shy to invest into stock market because some people call it a gambling.

Answer(3): CAPM- It is a capital asset pricing model. This model tells the linear relationship between required return and an investment. This model takes into account the Beta, beta is a measure of systematic risk.

Formula: Re = Rf + Beta (Rm- Rf)

Where; Re = Required return, Rm = Market return, Rf = Risk free return

This model has some assumptions:

• No transaction cost and tax.
• Investors are rational and risk averse.
• All the information is available to all the investors and traders.
• Investors are price takers and they cannot influence the prices.

Limitations of CAPM:

• In real world, there is always transaction cost and taxes that this model ignores.
• All the information is not available to the public, there is some confidential information that is limited to the company's key people only.
• All investors are not risk averse.
• Many investors do not diversify their portfolios in the planned manner and with proper analysis.
• Beta is unstable, it will not reflect the future volatility of returns.