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2. CONTENTS
• FEW TERMS
• CAPITAL ASSET PRICING MODEL
• BETA COEFFICIENT
• SECURITY MARKET LINE
• CAPITAL MARKET LINE
• ASSUMPTION OF CAPM
• BENEFITS OF CAPM
• DRAWBACKS OF CAPM
• CONCLUSION

3. FEW TERMS
RISK-RETURN TRADE OFF
• ALSO KNOWN AS RISK-RETURN SPECTRUM OR RISK-REWARD
• RELATIONSHIP BETWEEN RISK AND RETURN
EXPECTED RETURN
• IT IS IN EXCESS OF THE RISKLESS RATE
• BENEFIT FOR INVESTING IN THAT INVESTMENT OPPORTUNITY
• IT IS FOR THE FUTURE PERIOD

4. FEW TERMS
SYSTEMATIC RISK
• RISK OF THE ENTIRE MARKET AS A WHOLE
• DAY-TO-DAY FLUCTUATIONS IN STOCK’S PRICES
• IT IS AN UN-DIVERSIFIED RISK
UNSYSTEMATIC RISK
• RISK OF AN INDIVIDUAL COMPANY OR INDUSTRY
• IT DEPENDS COMPLETELY ON THE COMPANY
• IT IS DIVERSIFIED

5. CAPITAL ASSET PRICING MODEL
• IT CONSIDERS ONLY SYSTEMATIC RISK
• EXPLAINS THE BEHAVIOUR OF SECURITY PRICES
• SUGGEST THE DETERMINATION OF PRICES OF SECURITIES
• REFERS THAT THE SECURITIES ARE VALUED IN LINE
CAPM : 𝐸 𝑅𝑖 = 𝑅𝑓 + β (𝑅 𝑚 − 𝑅𝑓)

6. BETA COEFFICIENT
• RISK MEASUREMENT FACTOR
• NEGATIVE BETA WOULD BE HIGHLY UNLIKELY
β=1
Market Risk β>1
Higher Riskβ<1
Lesser Risk

7. SECURITY MARKET LINE
• EXPRESSES THE BASIC THEME OF THE CAPM
• IT IS AN UPWARD SLOPING STRAIGHT LINE WITH AN
INTERCEPT AT THE RISK-FREE RETURN SECURITIES
AND PASSES THROUGH THE MARKET PORTFOLIO.
• IT DISPLAYS THE EXPECTED RATE OF RETURN OF AN
INDIVIDUAL SECURITY.
𝐸 𝑅𝑖 = 𝑅𝑓 + β (𝑅 𝑚 − 𝑅𝑓)

8. CAPITAL MARKET LINE
• IT IS A TANGENT LINE DRAWN FROM THE POINT OF
RISK-FREE ASSET.
• IT REPRESENTS THE MARKET PORTFOLIO, SINCE ALL
RATIONAL INVESTORS SHOULD HOLD THERE RISKY
ASSET IN THE SAME PROPORTIONS AS THEIR
WEIGHTS IN THE MARKET PORTFOLIO.
𝐸(𝑟) = 𝑟𝑓 + σ
𝐸 𝑟 𝑀 − 𝑟𝑓
σ 𝑀

9. ASSUMPTIONS
ALL INVESTORS :-
• AIM TO MAXIMIZE ECONOMIC UTILITIES
• ARE RATIONAL
• ARE DIVERSIFIED
• ARE PRICE TAKERS
• CAN LEND AND BORROW UNLIMITED AMOUNT
• TRADE WITHOUT TRANSACTION AND TAXATION COST
• DEALS WITH HIGHLY DIVISIBLE SECURITIES
• HAVE HOMOGENEOUS EXPECTATIONS
• ALL INFORMATION IS AVAILABLE AT THE SAME TIME

10. BENEFITS OF CAPM
THERE ARE FEW ADVANTAGES TO THE APPLICATION OF CAPM
•EASE-OF-USE
•DIVERSIFIED PORTFOLIO
•SYSTEMATIC RISK
•BUSINESS AND FINANCIAL RISK VARIABILITY

11. DRAWBACKS OF CAPM
THE PRIMARY DRAWBACKS ARE REFLECTED IN THE MODEL’S INPUTS AND
ASSUMPTIONS :-
•RISK-FREE RATE
•RETURN ON THE MARKET
•ABILITY TO BORROW AT A RISK-FREE RATE
•DETERMINATION OF PROJECT PROXY BETA

12. CONCLUSION
NO MATTER HOW MUCH WE DIVERSIFY OUR INVESTMENTS, IT’S IMPOSSIBLE TO GET RID OF ALL THE RISKS.
AS INVESTORS, WE DESERVE A RATE OF RETURN THAT COMPENSATES US FOR TAKING ON RISK. THE CAPITAL
ASSET PRICING MODEL HELPS US TO CALCULATE INVESTMENT RISK AND WHAT RETURN ON INVESTMENT
WE SHOULD EXPECT.
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