Reference & Help - CAPM . Capital Asset Pricing Model ....

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CAPM . .. Capital Asset Pricing Model . ... Remember we talked earlier about how interest rates have various components . .. parts . .. inflation, risk free, maturity risk, liquidity risk, default risk . ..... Well the RETURN we expect on our investment is STOCKS also has parts. The CAPM is one way to estimate . .. to BUILD That RATE. Now this rate is just like the interest you get at the bank. You deposit $1000 in a savings accounts and you expect a certain return on your investment . .. INTEREST. Well with stocks the CERTAINTY of that return is not nearly the same, in fact it is not certain at all . .. but still we expect, we hope to make money. Now because of the uncertainty (higher RISK) we are looking for the potential of a higher reward. And in fact in the nearly 80 years of the stock market before this disastrous recession, the market as a whole averaged a 12.4% annual return on popular stocks. That includes the depression, WWII, Korean War, .etc., etc. The CAPM brings together certain PARTS to build the rate of return expected for an individual company. CAPM starts with a RISK FREE RATE as the base. Again we use U.S. Treasuries to establish that base. The next element is Beta . .. a correlation statistic between the historic movement of that particular stocks price and the value of the market as a whole. For example if a company's Beta is "1.00" . .. the the price of that stock historically moved in perfect tandem with the market. If the market as a whole was up 10% the it would be likely that that individual stock would be up 10% . .. If the market was down 10%, then it is likely that stock would also be down 10%. CAPM = Rf + Beta(Rm - Rf)
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This note was uploaded on 06/21/2010 for the course FINANCE MT217-04 taught by Professor Denise during the Spring '10 term at Kaplan University.

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Reference & Help - CAPM . Capital Asset Pricing Model ....

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