what is capm?

Question

i dont know

Answer 1

The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate required rate of return (and thus the price if expected cash flows can be estimated) of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's non-diversifiable risk. The CAPM formula takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), in a number often referred to as beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

The model was introduced by Jack Treynor, William Sharpe, John Lintner and Jan Mossin independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe received the Nobel Memorial Prize in Economics (jointly with Harry Markowitz and Merton Miller) for this contribution to the field of financial economics.

Asset pricing-

Once the expected return, E(ri), is calculated using CAPM, the future cash flows of the asset can be discounted to their present value using this rate (E(ri)), to establish the correct price for the asset.

In theory, therefore, an asset is correctly priced when its observed price is the same as its value calculated using the CAPM derived discount rate. If the observed price is higher than the valuation, then the asset is overvalued (and undervalued when the observed price is below the CAPM valuation).

Alternatively, one can "solve for the discount rate" for the observed price given a particular valuation model and compare that discount rate with the CAPM rate. If the discount rate in the model is lower than the CAPM rate then the asset is overvalued (and undervalued for a too high discount rate).

Asset-specific required return-

The CAPM returns the asset-appropriate required return or discount rate - i.e. the rate at which future cash flows produced by the asset should be discounted given that asset's relative riskiness. Betas exceeding one signify more than average "riskiness"; betas below one indicate lower than average. Thus a more risky stock will have a higher beta and will be discounted at a higher rate; less sensitive stocks will have lower betas and be discounted at a lower rate. The CAPM is consistent with intuition - investors (should) require a higher return for holding a more risky asset.

Since beta reflects asset-specific sensitivity to non-diversifiable, i.e. market risk, the market as a whole, by definition, has a beta of one. Stock market indices are frequently used as local proxies for the market - and in that case (by definition) have a beta of one. An investor in a large, diversified portfolio (such as a mutual fund) therefore expects performance in line with the market.

Risk and diversification-

The risk of a portfolio is comprised of systematic risk and specific risk. Systematic risk refers to the risk common to all securities - i.e. market risk. Specific risk is the risk associated with individual assets. Specific risk can be diversified away (specific risks "average out"); systematic risk (within one market) cannot. Depending on the market, a portfolio of approximately 15 (or more) well selected shares might be sufficiently diversified to leave the portfolio exposed to systematic risk only.

A rational investor should not take on any diversifiable risk, as only non-diversifiable risks are rewarded. Therefore, the required return on an asset, that is, the return that compensates for risk taken, must be linked to its riskiness in a portfolio context - i.e. its contribution to overall portfolio riskiness - as opposed to its "stand alone riskiness." In the CAPM context, portfolio risk is represented by higher variance i.e. less predictability.

The efficient (Markowitz) frontier-

The CAPM assumes that the risk-return profile of a portfolio can be optimized - an optimal portfolio displays the lowest possible level of risk for its level of return. Additionally, since each additional asset introduced into a portfolio further diversifies the portfolio, the optimal portfolio must comprise every asset, (assuming no trading costs) with each asset value-weighted to achieve the above (assuming that any asset is infinitely divisible). All such optimal portfolios, i.e., one for each level of return, comprise the efficient (Markowitz) frontier.

Because the unsystematic risk is diversifiable, the total risk of a portfolio can be viewed as beta.

The market portfolio-

An investor might choose to invest a proportion of his wealth in a portfolio of risky assets with the remainder in cash - earning interest at the risk free rate (or indeed may borrow money to fund his purchase of risky assets in which case there is a negative cash weighting). Here, the ratio of risky assets to risk free asset determines overall return - this relationship is clearly linear. It is thus possible to achieve a particular return in one of two ways:

By investing all of one’s wealth in a risky portfolio,
or by investing a proportion in a risky portfolio and the remainder in cash (either borrowed or invested).
For a given level of return, however, only one of these portfolios will be optimal (in the sense of lowest risk). Since the risk free asset is, by definition, uncorrelated with any other asset, option 2) will generally have the lower variance and hence be the more efficient of the two.

This relationship also holds for portfolios along the efficient frontier: a higher return portfolio plus cash is more efficient than a lower return portfolio alone for that lower level of return. For a given risk free rate, there is only one optimal portfolio which can be combined with cash to achieve the lowest level of risk for any possible return. This is the market portfolio.

Assumptions of CAPM:

-All investors have rational expectations.
-All investors are risk averse.
-There are no arbitrage opportunities.
-Returns are distributed normally.
-Fixed quantity of assets.
-Perfect capital markets.
-Separation of financial and production sectors.
-Thus, production plans are fixed.
-Risk-free rates exist with limitless borrowing capacity and universal access..

Answer 2

CAPM, stands for Capital Asset Pricing Model, Prof. Markowitz's brain child in 1953. When he was doing his PHD work in University of Chicago, he happened to have been waiting outside his guides office when a Stock broker also who was waiting there started a conversation with him about Stock pricing. The broker gave him some ideas of his and Markowitz thought that in his model risk and return were not related. Then he went ahead and studied the market and created a stock valuation model incorporating risk and return. This won him the Nobel prize for Economics in 1992.
The equation for CAPM is
Ks = krf +beta(km-krf) where Ks is the required stock return, krf is the discount rate, beta is the volatility of the stock with respect to market volatility, km is the market return. Krf is the required return for systematic risk which cannot be diversified away and the second part is the non-systematic risk which can be diversified away.Systematic risk is the Economy specific risk and the non-systematic risk is the Company specific risk.
The other peripheral formulas are,
P0=d1/ks-g and
from which we again get the Expected stock return formula as ks=d1/P0+g where,
P0 is the prior period stock price, g the growth rate, d1 is the next period dividend.
Dr. Sharpe was Prof. Markowitz student and is known to have created the CAPM model of today borrowing from his ideas.

Answer 3

What Is Capm

Answer 4

A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. You can find out more by Google or via free online courses. It wouldn t take much long cuz the videos are pretty precise. I can suggest you Bluebook Academy.

Answer 5

CAPM calculates expected return so when you have a higher beta, the CAPM is higher because you expect to get more in return for the risk you take. I think this is how I understood your question.

Answer 6

I'm sure it can stand for more than one thing.

In math/finance, it stands for the 'Capital Asset Pricing Model'.

Answer 7

https://bluebookacademy.com/courses/investment-decisions/video/capm-a-model-to-calculate-a-stock-s-expected-return

Answer 8

what do u mean