Directions
Within business, working professionals should become comfortable receiving and giving constructive feedback. Critical analysis of topics, and providing and receiving constructive feedback, is important in one’s professional growth and development and a core competency for leaders. You will be expected to read the initial posting of at least ONE peer or instructor, and then provide constructive criticism to their peers’ initial postings. You should highlight strengths as well as opportunities for improvement:
Each response should be a minimum of 250 words
Directions
Within business, working professionals should become comfortable receiving and giving constructive feedback. Critical analysis of topics, and providing and receiving constructive feedback, is important in one’s professional growth and development and a core competency for leaders. You will be expected to read the initial posting of at least ONE peer or instructor, and then provide constructive criticism to their peers’ initial postings. You should highlight strengths as well as opportunities for improvement:
1.
Point out what you perceived to be the strengths of the initial posting along with supporting rationale.
2. Identify specific opportunities for improvement with regard to the content in the initial posting. Furthermore, you should provide supporting rationale for your stated position, as well as concrete suggestions and guidance intended to strengthen the effectiveness of the content.
Each response should be a minimum of 250 words
Lisa Womble
Capital Asset Pricing Model (CAPM) and Assumptions
With investments there are risks and all risks must be assessed to make an investment based on reasonable expectations. The Capital Asset Pricing Model (CAPM) is used to assess risk to determine the fair market value of a stock and forecast expected returns. This model describes the relationship between risk and return (Berk & DeMarzo, 2020)
There are two types of risk that are important to consider when evaluating investments. Systematic risk or market risk is risk that relates to economic conditions, such as fluctuating interest rates, which affects the entire market and unsystematic risk which is risk associated with random events or company specific events, such as mismanagement, affects small groups of securities. Unsystematic risk is what is being assessed and reduced when one diversifies their portfolio as each stock has their own risk and do not correlate to other stocks in the portfolio. Systematic risk cannot be diversified away and regardless of the quantity of stocks, all of them share correlated risk; that risk is what is being assessed when utilizing the CAPM model (Cautero, 2021).
There are three assumptions that are used to translate the results more clearly. These assumptions eliminate those unknown factors that can’t be measured because they vary from investor to investor.
1.
1. Investors can buy and sell securities at competitive market prices and can borrow and lend at the risk-free interest rate (Berk & DeMarzo, 2020). This is basically stating the value of securities are determined by the market price, not the opinion of a single investor and when borrowing and lending, interest rates on loans will not be included in the model.
2. Investors hold only efficient portfolios of traded securities; portfolios that yield the maximum expected return for a given level of volatility (Berk & DeMarzo, 2020). This is basically stating that investors are interested in securities that yield the highest expected return and since all information on the securities is available to them, investments are made because they pay the highest returns with the least risk.
3. Investors have homogeneous expectations regarding the volatilities, correlations, and expected returns of securities (Berk & DeMarzo, 2020). This is basically stating investor preference is not considered and that the playing field is fair or even for all investors.
CAPM implies that an efficient portfolio is one that has been diversified to the point that it only contains systematic risk and offers the highest expected return for the given level of risk. Ideally, diversification can improve a portfolio’s overall level of risk and return as returns are dependent on the combination of investments that make up the portfolio. When more securities are added to a portfolio it adds more diversification thus improving the efficiency frontier. The efficiency frontier graphically depicts the benefits of diversification and investors use this information when creating a portfolio that maximizes expected returns based on their risk level.
Berk, J. B., & DeMarzo, P. M. (2020). Corporate Finance (5th ed.). Pearson.
Cautero, R. (2021, March 4). The Capital Asset Pricing Model (CAPM), explained. SmartAsset. Retrieved February 14, 2022, from
https://smartasset.com/investing/capital-asset-pricing-model (Links to an external site.)
Kenton, W. (2022, February 8). Capital Asset Pricing Model (CAPM). Investopedia. Retrieved February 14, 2022, from
https://www.investopedia.com/terms/c/capm.asp (Links to an external site.)
Mullins, D. W. (2014, August 1). Does the capital asset pricing model work? Harvard Business Review. Retrieved February 15, 2022, from
https://hbr.org/1982/01/does-the-capital-asset-pricing-model-work
