CAPM IN FINANCE WITH VARIOUS EXAMPLES.pptx

FR

1. Capital Asset Pricing Model By-Charit Pandey

2. What is CAPM? Definition:  A theoretical model that describes the relationship between the expected return of an asset and its systematic risk. Purpose:  Helps investors estimate the expected return they should demand for investing in a particular asset based on its inherent risk.

3. Key Assumptions Of CAPM Efficient Market Hypothesis: All available information is reflected in asset prices, making it impossible to consistently beat the market. Diversification Eliminates Unsystematic Risk: Unsystematic risk can be diversified away through holding a well-diversified portfolio, leaving only systematic risk as relevant. Investors Seek Optimal Return-Risk Trade-off: Investors aim to maximize expected return for a given level of risk or minimize risk for a given expected return. Risk-Free Rate and Market Return are Known: These values are used as benchmarks for the model.

4. Components Of CAPM Risk-Free Rate (Rf):  The return on an investment with no risk, typically represented by government bonds. Market Risk Premium (Rm - Rf):  The difference between the expected return of the market portfolio and the risk-free rate, representing compensation for taking on market risk. Beta (β):  A measure of an asset's systematic risk relative to the market. A β of 1 indicates the asset's movement aligns with the market, >1 means it's more volatile, and <1 means it's less volatile. Security Market Line (SML):  A graphical representation of the CAPM equation, showing the expected return for assets based on their beta

5. Equation Of CAPM Equation:  Ri = Rf + β i (Rm - Rf) Ri: Expected return of individual asset β i : Beta of individual asset Rf: Risk-free rate Rm: Expected return of the market portfolio Explanation: The equation tells us the expected return of an asset is equal to the risk-free rate plus a risk premium based on its beta. The higher the beta, the higher the expected return to compensate for the higher systematic risk.