Asked by Jamilla Cason on Apr 26, 2024
Verified
In the first chapter, it was stated that financial managers should act to maximize shareholder wealth. Why are the efficient markets hypothesis (EMH), the CAPM, and the SML so important in the accomplishment of this objective?
Efficient Markets Hypothesis (EMH)
The hypothesis is that actual capital markets, such as the TSX, are efficient.
CAPM
Capital Asset Pricing Model, a theory that describes the relationship between systematic risk and expected return for assets, particularly stocks.
- Explain the principles of the efficient market hypothesis and its consequences on the relationship between risk and reward.
- Gain an understanding of the components and the structure of the Capital Asset Pricing Model (CAPM).
- Clarify the role of the Security Market Line (SML) and how it correlates with the Capital Asset Pricing Model (CAPM).
Verified Answer
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Taylor ForteApr 30, 2024
Final Answer :
In simple terms, one could say that maximizing shareholder wealth by maximizing the current share price (File: Chapter 1) is a reasonable objective if and only if we have some assurance that observed prices are meaningful; i.e., that they reflect the value of the firm. This is a major implication of the EMH. Further, if we are to be able to assess the wealth effects of future decisions on security and firm values, we must have a valuation model whose parameters can be shown to be affected by those decisions (Chapters 7 & 8). Finally, any valuation model we employ will require us to quantify return and risk (Chapters 12 and 13).
Learning Objectives
- Explain the principles of the efficient market hypothesis and its consequences on the relationship between risk and reward.
- Gain an understanding of the components and the structure of the Capital Asset Pricing Model (CAPM).
- Clarify the role of the Security Market Line (SML) and how it correlates with the Capital Asset Pricing Model (CAPM).