Presented by:

Arpit Agarwal

Heena Banka

Pooja Chandak

overviewAbout CAPM

Assumptions of CAPM

Market Efficiency

Advantages of CAPM

Disadvantages of CAPM

Conclusion

ABOUT CAPM

It represents the linear relationship between the return

required on an investment and its systematic risk

It is represented by the formula:

Ke = Rf +β (Rm – Rf)

Ke = Risk free rate + Risk premium

BETA (SYSTEMATIC RISK)

β = cov. (K e , R m )

δM2

Value of β Characteristics of security

β < 1 Less sensitive to market

β = 1 Equally sensitive to market

β > 1 More sensitive to market

SML

Rf

β

SMLX

SML

Rf

β

SML

Y

ASSUMPTIONS OF CAPMInvestors hold diversified portfolios

Single-period transaction horizon

Investors can borrow and lend at the risk-free rate of

return

Perfect capital market

MARKET EFFICIENCY

Market efficiency has varying degrees:

Weak efficiency

Semi-strong

Strong

WEAK EFFICIENCY

No investor can earn excess returns by developing

trading rules based solely on historical price or return

information

SEMI-STRONG EFFICIENCY

No investor can earn excess returns from using trading

rules based on any publicly available information

STRONG EFFICIENCY

No investor can earn excess returns using any

information whether publicly available or not

ADVANTAGES OF CAPMIt considers only systematic risk, reflecting a reality in

which most investors have diversified portfolios from which unsystematic risk has been essentially eliminated

It generates a theoretically-derived relationship between required return and systematic risk which has been subject to frequent empirical research and testing

It is generally seen as a much better method of calculating the cost of equity than the dividend growth model (DGM) in that it explicitly takes into account a company’s level of systematic risk relative to the stock market as a whole

DisadvantagesThe model assumes that asset returns are (jointly)

normally distributed random variablesThe model assumes that the variance of returns is an

adequate measurement of riskThe model does not appear to adequately explain the

variation in stock returnsThe model assumes that given a certain expected

return investors will prefer lower risk (lower variance) to higher risk and conversely given a certain level of risk will prefer higher returns to lower ones

Contd……The model assumes that all investors have access to

the same information and agree about the risk and expected return of all assets

The market portfolio should in theory include all types of assets that are held by anyone as an investment (including works of art, real estate, human capital...)

conclusion

Research has shown the CAPM to stand up well to criticism, although attacks against it have been increasing in recent years. Many other models have been developed which are used extensively these days like Fench and Fama Model. However, the CAPM remains a very useful item in the financial management toolkit.

THANK YOU!!!!!!