CAPITAL%20ASSET%20PRICING%20%20%20%20%20%20MODEL(CAPM)

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CAPITAL ASSET PRICING
MODEL(CAPM)
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CAPITAL ASSET PRICING MODEL(CAPM)

• It is developed by Professors Sharpe Markowitz
  in 1960. Prof Sharp won Nobel Prize in 1990

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Types of investors

• Risk taker The investor who take risk.
• Risk Aversor The investor who avoided risk and
  if he take risk he ask for more reward and in
  this case it is risk premium.

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CAPM Defined

• It is a model which describes the relationship
  between risk and expected (required) return.
• In this model a security expected (Required)
  return is equal to risk free rate and risk
  premium based on the systematic risk of the
  security.

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• Mathematically CAPM is written as

Rj Rf Bj (Rm Rf)
Where Rj Required (expected) rate of return
of security j Rf Risk free rate of short term
govt bond Bj It is the systematic risk of
security j which can not be diversified. Rm
Required rate of return of market (KSE 100
index) (Rm Rf) Risk premium because of
bearing risk B (beta)
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Assumption of CAMP

• The capital market is efficient, in that investor
  are well informed.
• No transaction cost.
• Negligible restriction on investment.
• No investment is large enough to effect the
  market price of a stock.
• There is no taxes.
• The quantities of all assets are given fixed.
• All assets are perfectly divisible and perfectly
  liquid.

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Investment Opportunities

1. Investment in risk free securities whose return
   are fixed. Short term rate is used is CAPM.
2. Market portfolio of common stock.

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Beta

• It is a tendency of a Stock to move with the
  Market (or Portfolio of all Stocks in the Stock
  Market). it is the building block of CAPM.
• Total Risk Diversifiable Risk Market Risk
• Total Stock Return Dividend Yield Capital
  Gain Yield

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Stock Risk Vs Stock Beta

• Stock Risk
• It is a statistical spread of possible returns
  (or Volatility) for that Stock
• Stock Beta
• It is a statistical spread of possible returns
  (or Volatility) for that Stock relative to the
  market spread i.e. spread (or Volatility) of the
  fully diversified market portfolio or index.
• Beta Coefficients of Individual Stocks are
  published in Beta Books by Stock Brokerages
  Rating

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Meaning of Beta for Share ABC in Karachi Stock
Exchange (KSE)

• If Share As Beta 2.0 then that Share is Twice
  as risky (or volatile) as the KSE Market i.e. If
  the KSE 100 Index moved up 10 in 1 year, then
  based on historical data, the Price of Share B
  would move up 20 in 1 year.
• If Share Bs Beta 1.0 then that Share is
  Exactly as risky (or volatile) as the KSE Market
• If Share Cs Beta 0.5 then that Share is only
  Half as risky (or volatile) as the KSE Market
• If you could find a Share D with Beta -1.0 then
  that share would be exactly as volatile as the
  KSE Market BUT in the opposite way i.e. If the
  KSE 100 Index moved UP 10 then the price of the
  Share D would move DOWN by 10!
• The Beta of most Stocks ranges between 0.5 and
  1.5
• The Average Beta for All Stocks Beta of Market
  1.0 Always.