Question

It is known that financial managers should act to maximize shareholder wealth. Why are the efficient markets hypothesis (EMH), the CAPM, and the SML so important in the accomplishment of this objective?

Answer 1

We can say that a shareholders wealth is maximized by maximizing the share's price. The assurity that the price of the shares are meaningful i.e. it contains all the information, is the main implication of EMH. Further, if we want to assess the wealth effect of future decisions on security value , we need a valuation model whose parameters can be seen affected by those decision. This is the time when CAPM model comes in use. Last but not the least any valuation model we use, we need to quantify the risk and return. This is the time when SML comes in picture, where we see the trade of between return and systematic risk.