Capital Asset Pricing Model Essay Example | Topics and Well Written Essays - 1500 words

Capital Asset Pricing Model - Essay Example The underlying theme associated with CAPM is investor’s relationship and the advantages which an investor can attain by the application of this model. The investors are linked in two ways with this technique; one is the time value of money and the other is the risk factor involved in a project. The time value of money can be depicted using the risk-free (Rf) rate in the formula which can then be compensated with the investors for placing money in any investment after a certain period of time. The risk part of CAPM formula is used for representation of risk and calculates only the amount of compensation which any investor can undertake for facing any additional risk. These financials can be calculated using the risk measurement tool i.e. beta, which has the ability to compare the returns of the asset towards the market after a certain period of time having definite market premium. According to the CAPM tool, the expected return of a security calculated on a portfolio is equal t o the rate of a risk-free security, which is further raised by including a risk premium. If this is expected return is not able to be ascertained or is not able to even beat the expected return then the required return and the investment will not be undertaken. Practical Implementation of CAPM This pricing model which is regarded as CAPM was put forwarded in the year 1960 and since then it is under deep influence of criticisms. The argument of such critics involves hypothesis that CAPM does not put forward realistic market conditions.