Capital Asset Pricing Model (CAPM)

Question 1

The Portfolio Effect

Answer 1

~ ‘not putting all your eggs in one basket’

~ a combination of investments causes the rate of return to equal out

Question 2

Unsystemic risk

Answer 2

~ can be elimiated by diversification

~ casued by industry/company specific factors

Question 3

Systemic risk

Answer 3

~ cannot be elimiated by diversification

~ caused by general economic factors

Question 4

CAPM

Answer 4

used to measure the systemic risk of investments and their required returns
Decision: >1, investment more affected by macroeconomic/systemic factors

Question 5

High betas

Answer 5

agressive shares

Question 6

Low betas

Answer 6

defensive shares

Question 7

In a bull market…

Answer 7

should buy high beta shares

market expected to rise

Question 8

In a bear market…

Answer 8

should buy low beta shares

market expected to fall

Question 9

CAPM Weaknesses

Answer 9

~ S/H may not diversify
~ depends on a perfect capital market
~ betas change over time and are difficult to calc

Question 10

CAPM Alternatives

Answer 10

~ alpha value
~ Arbitrage Pricing Model (APM)
~ Fama-French 3-factor model
~ Bond-yield-plus premium approach
~ Fundemental beta

Question 11

Alpha value

Answer 11

a measure of how wrong CAPM is
Decision: +ve, buy shares in co
-ve, sell shares in co

Question 12

Arbitrage Pricing Model (APM)

Answer 12

uses factor analysis to determine which independent factors the security is sensitive to

Question 13

Fundamental beta

Answer 13

where a company’s CF are subjected to higher risk, the required return should be higher
(same as risk adjusted cashflow)