CAPM APT Flashcards
What is systematic risk? aka market risk
This is non-diversifiable risk
What is the Security Market Line (SML) equation?
Rf + Beta * (Market risk Premium)
What are the three determinants of systematic risk exposure?
- The sensitivity of the company’s revenues to the general level of economic activity in the economy and other macro factors.
- The proportion of fixed to variable costs (cost sensitivity)
- The level of financial gearing or leverage
What does beta value indicate?
The degree of responsiveness of the expected returns on the shares, relative to movements in the expected return on the market. It does not indicate the total volatility of returns, but only the extent to which it is likely to react to overall market movements.
What does beta measure?
The degree to which a shares risk premium varies as the average risk premium on the stock market varies
What is alpha?
The average abnormal return
What does the CAPM model assume about investors (5)
- They are rational, risk-averse, utility maximisers
- They perceive utility in terms of return
- They measure risk by standard deviation of returns
- They have a single-period time horizon.
- They all have the same expectations about what the uncertain future holds.
What does the CAPM model assume about markets (3)
- No taxes
- No transactions costs
- Investors can lend and borrow at the risk free rate
Difference between CAPM and APM
CAPM is single factor - APM is multi factor. APM uses a set of beta values, one for each factor
Arbitrage pricing theory APT states that
the expected return on investment is dependent upon how that investment reacts to a set of individual macroeconomic factors and the risk premium associate with each of these factors
Identified factors of APM (7)
- Changes in the level of industrial production in economy
- Changes in shape of yield curve
- Changes in default risk premium (bonds)
- Changes in inflation rate
- Changes in real interest rate
- Level of personal consumption
- Level of money supply in economy
