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Questions and Answers
What does the CAPM primarily estimate?
What does the CAPM primarily estimate?
In the CAPM formula Rs = Rf + βs (Rm – Rf), what does Rf represent?
In the CAPM formula Rs = Rf + βs (Rm – Rf), what does Rf represent?
According to CAPM, how does the beta of an asset affect the expected return?
According to CAPM, how does the beta of an asset affect the expected return?
What expected portfolio return corresponds to a portfolio beta of 0.4?
What expected portfolio return corresponds to a portfolio beta of 0.4?
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What implication does CAPM have regarding investment risk and expected return?
What implication does CAPM have regarding investment risk and expected return?
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Study Notes
Capital Asset Pricing Model (CAPM)
- The CAPM estimates the expected return on an investment based on its systematic risk.
- The formula for CAPM is: Rs = Rf + βs (Rm – Rf)
- Rs is the expected return on the stock or the company's cost of equity capital.
- Rf is the risk-free rate.
- Rm is the expected return on the stock market.
- βs is the stock's beta.
- CAPM indicates that investors require a higher rate of return on investments with higher betas, highlighting the relationship between risk and return.
Risk and Return for Portfolios
- The CAPM links the expected rate of return of an asset to its beta: (rAsset j) = rf + β Asset j [E (rMarket) – rf]
- The higher the systematic risk of an investment, the higher the expected return an investor expects to receive.
Implications and Applications
- CAPM is used to determine expected returns and assess the risk-return trade-off in real-world investment scenarios.
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Description
Test your understanding of the Capital Asset Pricing Model (CAPM) and its implications on risk and return. This quiz covers the key components, formulas, and applications of CAPM in real-world investment scenarios. Suitable for finance students and professionals looking to enhance their knowledge of investment analysis.
