Asked by Cassi Crews on May 06, 2024
Verified
Write out the equation for the CAPM. Using the symbols in the model, identify the expected return on each of three assets: Asset A has a beta of one, Asset B has a beta of zero, and Asset C has a beta of negative one. In each case, interpret your result.
CAPM
Capital Asset Pricing Model; a model that describes the relationship between systematic risk and expected return for assets, particularly stocks.
Expected Return
The expected profit from an investment, calculated by considering the likelihood of various potential results.
Beta
A measure of a stock's volatility in relation to the overall market; a beta above 1 means the stock is more volatile than the market, while a beta below 1 means it is less volatile.
- Achieve insight into the workings and elements of the Capital Asset Pricing Model (CAPM).
Verified Answer
HS
Harwinder SinghMay 12, 2024
Final Answer :
This is a relatively straightforward application of the CAPM, but it does require students to fully understand the implications of the model. Clearly, Asset A is expected to earn the market return while Asset B is expected to earn the risk free rate. Asset C is a little tougher to explain. Students would likely expect that since it has a beta of negative one, it should have an expected return equal to the negative of the market return. However, it is expected to earn 2Rf - E(Rm).
Learning Objectives
- Achieve insight into the workings and elements of the Capital Asset Pricing Model (CAPM).