Question

What is the Capital Asset Pricing Model (CAPM)? Explain each variable in CAPM. What is the Security Market Line (SML)? Please feel free to expand on your answers.

Answer #1

Capital Asset Pricing Model (CAPM) - It is very important to know the value of an asset / stock before its investment. One best method to calculate that is through CAPM approach. This method helps in calculating the expected returns of the stock.

This method describes the relationship between risk of the stock, its price and the return.

The formula to calculate CAPM is Rf + Beta (Rm - Rf)

The variables of CAPM method are

Rf = risk free rate of an investment

Rm = The expected return of market portfolio

Beta = B = Stock's risk.

With this formula, we will be able to arrive with the expected return from an investment.

**Security Market
Line -**

This is the line which shows graphical representation of CAPM on a chart. This helps presents the market risk in X axis and the expected returns of a particular security in Y axis. The market risk premium is identified by seeing line plotted on the chart.

This method helps in technical analysis of a particular stock and identify whether it is overvalued or undervalued. This thereby helps the investors in taking important investment decisions.

In the theoretical Capital Asset Pricing Model (CAPM), the slope
of the Securities Market Line (SML) is determined by the value of
beta. True or False?

Which of the following statements about the Capital Asset
Pricing Model (CAPM), which is the “father” of the Security Market
Line (SML), is most correct?
A
The CAPM is based on a restrictive set of assumptions.
B
It has not been empirically verified.
C
In general, its inputs are difficult to estimate.
D
In spite of its deficiencies, it provides investors with a
rational way of thinking about required rates of return.
E
All of the above responses are correct.

Manipulating CAPM Use the basic equation for the capital asset
pricing model (CAPM) to work each of the following problems.
a. Find the required return for an asset with a beta of 0.54
when the risk-free rate and market return are 6 % and 8 % ,
respectively.
b. Find the risk-free rate for a firm with a required return
of 6.368 % and a beta of 0.26 when the market return is 11 % .
c. Find the market...

Explain what the capital asset pricing model (CAPM) is mainly
used for, and its theoretical foundation.

Explain why this statement is true or false: The capital asset
pricing model predicts that security with a beta less than zero
will provide an expected return higher than the market portfolio
return.
Explain why this statement is true or false: According to CAPM,
the price of a security will fall if its expected rate of return
lies above the security market line.

Use the basic equation for the capital asset pricing model
(CAPM) to work each of the following problems.
a. Find the required return for an asset with a beta of 0.84
when the risk-free rate and market return are 77% and 15 %
respectively.
b. Find the risk-free rate for a firm with a required return of
7.394% and a beta of 1.16 when the market return is 7 %.
c. Find the market return for an asset with a...

Use the basic equation for the capital asset pricing
model(CAPM) to work each of the following problems.
a. Find the required return for an asset with a beta of 1.51
when the risk-free rate and market return are 8% and 10%
respectively.
b. Find the risk-free rate for a firm with a required return of
9.791% and a beta of 0.97 when the market return is 10%.
c. Find the market return for an asset with a required return of...

Compare and contrast Capital Asset Pricing Model (CAPM) with
Arbitrage Pricing Theory (APT). What is the single most important
issue with CAPM? Which model is more realistic? Why?

According to the capital asset pricing model (CAPM), where does
an asset’s expected return come from? Please explain each
component.

Manipulating CAPM???Use the basic equation for the capital asset
pricing model ?(CAPM?) to work each of the following problems.
a.??Find the required return for an asset with a beta of 0.810.81
when the? risk-free rate and market return are 99?% and 17 %17%?,
respectively. b.??Find the ?risk-free rate for a firm with a
required return of 12.98212.982?% and a beta of 1.891.89 when the
market return is 10 %10%. c.??Find the market return for an asset
with a required return...

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