Compare and Contrast Pricing Models

| May 7, 2019

 

Instructions

Evaluate the development of the Capital Asset pricing Model (CAPM) in a paper. Identify and analyze the different applications to the CAPM, looking at consumption-based CAPM and the zero-beta model. Be clear in illustrating how the model can be used to form important expected return measures and in turn valuation measure. Some of the illustrations should be from stock options and restricted stock. Conduct a comparative analysis of the potential outcomes associated and comparative benefits and risks for using the capital asset pricing model (CAPM) verse the arbitrage pricing theory (APT).

Support your paper with minimum of five (5) resources. In addition to these specified resources, other appropriate scholarly resources, including older articles, may be included.

Length: 5-7 pages not including title and reference pages

Your paper should demonstrate thoughtful consideration of the ideas and concepts presented in the course and provide new thoughts and insights relating directly to this topic. Your response should reflect scholarly writing and current APA standards.

Capital Asset Pricing Model (CAPM)

Bodie, Kane, and Marcus (2014) state that the CAPM assumes that investors are single-period planners who agree on a common input list from security analysis and seek mean-variance optimal portfolios. The CAPM assumes that security markets are ideal in the sense that:

a. They are large, and investors are price-takers.

b. There are no taxes or transaction costs.

c. All risky assets are publicly traded.

d. Investors can borrow and lend any amount at a fixed risk-free rate.

With these assumptions, all investors hold identical risky portfolios. The CAPM holds that in equilibrium the market portfolio is the unique mean-variance efficient tangency portfolio. Thus a passive strategy is efficient. The CAPM market portfolio is a value-weighted portfolio. Each security is held in a proportion equal to its market value divided by the total market value of all securities. If the market portfolio is efficient and the average investor neither borrows nor lends, then the risk premium on the market portfolio is proportional to its variance, σ2M , and to the average coefficient of risk aversion across investors, A:

https://ncuone.ncu.edu/content/enforced/93949-FIN-7013/GlobalImages/CAPM_image_01.jpg?_&d2lSessionVal=GlGZWs5QXOTu75DuMjHAMigTj&ou=93949

The CAPM implies that the risk premium on any individual asset or portfolio is the product of the risk premium on the market portfolio and the beta coefficient:

https://ncuone.ncu.edu/content/enforced/93949-FIN-7013/GlobalImages/CAPM_image_02.jpg?_&d2lSessionVal=GlGZWs5QXOTu75DuMjHAMigTj&ou=93949

where the beta coefficient is the covariance of the asset with the market portfolio as a fraction of the variance of the market portfolio:

https://ncuone.ncu.edu/content/enforced/93949-FIN-7013/GlobalImages/CAPM_image_03.jpg?_&d2lSessionVal=GlGZWs5QXOTu75DuMjHAMigTj&ou=93949

Review the resources listed in the Books and Resources area below to prepare for this week’s assignment.

Bodie, Z., Kane, A., & Marcus, A. J. (2013). Investments New York, NY McGraw-Hill-Irwin.

Read Chapter 9

Carere, J. (2010, July 21). Capital Asset Pricing Model (CAPM) [Video file].

https://youtu.be/OyN8zN64Ceg

Graulich, V. (2013, March 3). CAPM: Capital Asset Pricing Model (a simple model of the Security Market Line) [Video file].

https://youtu.be/8w43SUAZsY0

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