CAPM
CAPM
CAPM
MEANING
Was developed by William Sharpe (1964), John Lintner (1965) and Jan
Mossin (1966).
It is based on the foundations of Modern Portfolio Management laid by
Harry Markowitz in 1952.
CAPM predicts the relationship between the risk of an asset and its expected
return
It helps in the identification of different securities (individual asset or
portfolio) as overpriced or underpriced by assigning values (not exact) to
these securities
This would help in selection of securities to be included in the portfolio by
the risk-averse investors.
Assumptions of Capital Asset Pricing Model
• The investors are risk averse i.e. they attempt to avoid risk.
• Investors seek to maximize the expected utility of their portfolio
• Each security has only two attributes - mean returns and variances of
such returns representing the risk.
• The market is perfect, there are no taxes, there are no transaction
costs, securities are completely divisible, and markets are
competitive.
• The quantity of risky securities in the market is given.
• Market it efficient
Security market line
• The SML shows the relationship between risk measured by beta and
expected return. The model states that the stock’s expected return is
equal to the risk free rate plus a risk premium obtained by the price
of the risk multiplied by the quantity of the risk