Question

What is CAPM model. Discuss how can one derive the quantity called "beta" in that model.

Answer 1

Ans : CAPM - CAPM model means Capital asset pricing model. It describes the relational ship between the expected return of stock or portfolio that contains diversified stock and risk of the stocks or portfolio.

Expected return of the stock can be calculated as follows

E(r) = Rf + Beta ( MP)

E(r) = Expected return of the stock

Rf = risk free return

Beta = risk of the stock

MP = Market premium

Beta is the risk relative to the market. Beta describes the volatility of the stock with respect to the market.

Beta can be calculated as follows

Beta = ( E(r) - Rf ) / MP