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If any one investing money on securities need to assumecertain
level of risk on returns.
CAPM model to determine what return they get from that
risk.
CAPM demonstrated how risk and return can be linked
together specified the nature of the risk-return
relationship
for any security or asset.
Securities market means all risk CAPM divide that risk in to
two part:
Total Risk= systematic+ unsystematic risk
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CAPM basically divided in to five parts:
1. The beta coefficient, ();
2. The CAPM equation;
3. The CAPM graphthe security market line (SML);
4. Shifts in the SMLinflationary expectations and
riskaversion;
5. Comments and criticisms of the CAPM.
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Beta value basically explains the stability of the company
in
stock market .
If company is giving returns according to the market returns
than beta value is constant and vice-versa
Beta is simply the change in the excess return on the stock
over the change in excess return on the market portfolio.
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BETA VALUE DETERMINATION:
A shares beta is determined from the historical values of
theshares returns relative to market returns.
It is important to appreciate therefore that beta is a
relative,
not inabsolute, measure of risk.
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Beta = covariance
Variance
covariance: mean value of share return and market
return.Variance: square of the standard deviation of market
return
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CAPM EQUATION
E(r)=Rf+(ERmRf)
Derivation:
E(r) =required return on asset/share
Rf =risk-free rate of return
=beta coefficient for asset/share
ERm=expected market return, that is the return expected on
the market portfolio of shares
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SECURITY MARKET LINE:
When the CAPM equation is shown in graph form, the
resultant straight line is referred to as the security
market
line (SML).
The SML represents the level of return expected in the
market
for each level of the shares beta (market risk)
It is the line which exhibits the positive relationship
(correlation) between the systematic risk of a security and
its
expected return
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Basically SML shows the expected return of market.
It compares the company returns with market returns.
SML not give exact data when economy changes again
and again like inflation or deflation etc
We cant rely 100% on these data.
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