Capital Asset Pricing Model

Abu Bakar Manaf

ZH-132-030
Section-B
 What is Capital Asset Pricing Model (CAPM)?

 The classic theory that links risk and return for all
assets.
 The capital asset pricing model (CAPM) links
nondiversifiable risk to expected returns.
 The Equation of CAPM

Where,
rj= expected return or required return on asset j
RF= risk free rate of return, commonly measured by the return on a U.S.Treasury
Bill
bj = beta coefficient or index of nondiversifiable risk for asset j
rm = expected return on the market portfolio of assets
 Why CAPM is Important?

  It is vital in calculating the WACC, as CAPM

computes the cost of equity.
  It can be used to find the net present value (NPV)
of the future cash flows of an investment and to
further calculate its enterprise value and finally its
equity value.
 Assumptions of Capital Asset Pricing
Model (CAPM)

 The model aims to maximize economic utilities.

 The results are risk-averse and rational.
 The model can lend and borrow unlimited amounts
under the risk-free rate of interest.
 The model trades without taxation or transaction
costs.
 The model deals with securities all of which are
highly divisible into small parcels.
 
Thank You!