CAPM

Question 1

What does CAPM State?

Answer 1

That because non systemic risk can be eliminated by diversification, it is not rewarded.

CAPM It is the sensitivity of the security to the market that is the appropriate measure of risk.

Question 2

What is the return of an asset according to CAPM?

Answer 2

The risk free return plus a risk premium

Question 3

How do you determine the risk premium?

Answer 3

The level of the securities systemic risk

Question 4

What should you think of when you think of CAPM?

Answer 4

Beta and largely disproved

Question 5

What is CAPM formula

Answer 5

Risk free + (Beta x (Expected Return – Risk Free))

Question 6

Benefits of using CAPM?

Answer 6

Easy to calculate / info widely available

Takes account of systemic risk

Reflects fact that most portfolios are diversified to reduce non systemic risk

Robust / Trusted

Gives an expected return / benchmark

Question 7

CAPM Limitations

Answer 7

Studies have shown than not all systemic risk can be eliminated through diversification

Beta’s are historic and can be unreliable

Historic returns on US Stock Market to that expected by CAPM and found no relation at all