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Risk and Return: Capital Asset Pricing Model (CAPM)【Deric Business Class】 - YouTube
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hey guys welcome to Derek business class
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in this video I'm gonna talk about the
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capital asset pricing model cap n in the
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early 1960s finance researchers Sharpe
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Treanor and Lintner developed an asset
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pricing model that measures only the
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amount of systemic risk a particular
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asset has in other words they noticed
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that most stocks go down when interest
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rates go up but some go down a whole lot
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more they reason that if they could
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measure this variability the systematic
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risk then they could develop a model to
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price assets using only this risk to
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price assets means to calculate the
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lowest minimum return based on market
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risk the unsystematic risk or company
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unique risk is irrelevant because it
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could easily be eliminated through
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diversification
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to measure the amount of systemic risk
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an asset has they regressed the returns
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for the market portfolio against the
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returns for an individual asset the
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slope of the regression line beta
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measures an asset systematic or non
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diversifiable risk it's a measure of the
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sensitivity of an individual stocks
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returns to changes in the market in
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general cyclical companies like auto
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companies have high betas while
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relatively stable companies like public
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utilities have low betas to calculate
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beta we regress a market returns against
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the company returns y axis represents
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company returns while x axis represents
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market returns the slope of the
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regression line is beta mathematically
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beta is calculated based on Delta Y over
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Delta X simply speaking the change in Y
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over the change in X you will get the
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beta for the meanings of beta a firm
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that has a beta equals one has average
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market risk the stock is no more or less
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volatile than the market volatile means
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risky a firm with a beta greater than 1
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is more volatile than the market for
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example technology firms a firm with
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abate is smaller than 1 is less volatile
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than the market for example utilities
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when beta equals 0 that's when firms
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return equals risk-free rate when beta
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is positive firms return is moving
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together with market return when beta is
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negative firms return is moving in
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opposite with market return
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look at this table two companies with
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the lowest beta and Heiser Busch and
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Pepsi both companies are from beverages
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industry they have a low beta because
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they are less risky but yahoo has the
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highest beta showing that Internet and
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Technology industry is more risky the
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beta of a portfolio can be estimated by
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considering the betas of the individual
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component assets in the portfolio
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according to the formula portfolio beta
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is calculated based on the summation of
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weight of asset times beta Fassett let's
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put it into calculation betaf portfolio
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V is 1 point 2 0 while the beta of
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portfolio W is 0.9 one portfolio V has
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higher beta than portfolio W which means
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portfolio V is more responsive to the
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market that is riskier
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after estimating the beta which measures
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a specific asset or portfolio systematic
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risk estimates of the other variables in
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the model may be obtained to calculate
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an asset or portfolios required return
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this is what we call the capital asset
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pricing model cap M according to the
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formula required return equals to
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risk-free rate plus market return minus
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risk-free rate times beta the required
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return for all assets is composed of two
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parts the risk-free rate and a risk
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premium the risk-free rate RF is usually
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estimated from the return on t-bills the
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risk premium is a function of both
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market conditions and the asset itself
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as shown in the formula of risk premium
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the risk premium for a stock is composed
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of two parts the market risk premium
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which is a return required for investing
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in any risky asset rather than the
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risk-free rate as shown in the formula
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of market risk premium beta a risk
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coefficient which measures the
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sensitivity of a particular stocks
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return to the changes in market
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conditions let's take an example
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Calvin wishes to determine the required
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return on asset Z which has a beta of
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1.5 the risk-free rate of return is 7%
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the return on the market portfolio of
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assets is 11% substituting beta equals
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1.5 RF equal 7% in R M equals 11% into
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the cap M yields a return of 13 percent
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this is the required return
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there are some comments on the cap M the
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cap M relies on historical data which
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means the beta's may or may not actually
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reflect the future variability of
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returns therefore the required return
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specified by the model should be used
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only as rough approximations the cap M
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also assumes markets are efficient
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although the perfect world of efficient
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markets appears to be unrealistic
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studies have provided support for the
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existence of the expectation already and
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active markets such as the New York
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Stock Exchange NY se let's look at
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another example the management is
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considering buying one of the two
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portfolios of assets a or B and has been
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given the following data calculate the
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expected return of each portfolio which
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provides the largest expected return so
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based on the formula you will get the
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expected return for portfolio a equals
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21 percent while the expected return for
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portfolio B equals 24 percent
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therefore portfolio B provides the
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largest expected return next part of the
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question now the management wishes to
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assess which portfolio has performed
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better on the basis of cap M they
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estimated betas for a and B of 1.2 and
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1.8 respectively risk-free rate is 8%
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market return is 18 percent using cap M
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identify which of the two portfolios has
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performed better by using cap m formula
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you will get the required return for a
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equals 20 percent while required return
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for B equals 26 percent so based on cap
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M portfolio B performed better let's
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compare the required return to the
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expected return we just calculated for
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portfolio a required return 20% expected
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return 21 percent
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it means portfolio a over performed the
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expected is higher than the required for
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portfolio be required returns
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six percent expected return twenty four
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percent so portfolio B underperformed
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the expected is lower than the required
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as a conclusion when the required return
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is smaller than the expected return
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investors should buy or accept the
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investment very likely stock price may
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rise in the future when the required
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return is greater than the expected
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return investor should sell or eject the
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investment very likely stock price may
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decline in the future
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all right that's all for this video
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thanks for watching see you in the next
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one
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bye
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