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Capital Asset Pricing Model | CAPM

   

Added on  2019-12-28

9 Pages1494 Words184 ViewsType: 184
Finance
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CAPITAL ASSET PRICINGMODEL
Capital Asset Pricing Model | CAPM_1

TABLE OF CONTENTSINTRODUCTION...........................................................................................................................1CONCLUSION................................................................................................................................4REFERENCES................................................................................................................................5
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INTRODUCTIONAny organisation runs to earn profits and have maximum returns on their investment. So,companies appoint a financial manager whose tasks is to suggest ways by which company canearn maximum cost on investment by operating at minimum cost. The managers face difficultiesin calculating cost of equity of firm. This has induced to make a new way to calculate this costby easier method. CAPM or Capital Asset Pricing Model is a method by which firms use to fixrates of securities and calculate expected rate of return on investments (Kaplan & Atkinson,2015). This model helps in calculating risks involved as well so that managers can plan theirmove in advance. This model has proved to be useful in many areas yet its application is stillquestionable by some experts. So, the present report will discuss the importance and argumentsrelated to this model. Meaning of CAPMCAPM is a theory which helps in measuring relationship between risk and return. This modelis an advanced version of former Portfolio theory which was used to analyse relationshipbetween risks and return (Wang & Xia, 2012). This model is based on assumptions as well whichbelieves that all the players in market have perfect knowledge of market. Besides this, it alsoassumes that investors want more as much return on their investment as much they have takenrisk. The model also implies some more things which are as under:Relationship existing between risk and return for a particular portfolio, assets andsecurities.Pricing of securities which are yet to be traded in market.Cost of equity and capital budgeting decision.Diversification of risks by investing in different portfolios (Bossaerts, 2013).There are some assumptions as well related to this theory which is discussed below:This model ignores unsystematic risk of capital and assumes that investors are concernedwith returns on systematic risks only. It also assumes that investors borrow and lend money at risk free rate.Another assumption made by this model is existence of perfect capital market, wheretrades are done freely, without any tax burden and similar expectations of investors. 1
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