Home     About Us    Contact Us     Contribute     Privacy
Mutual Funds
Related Articles
Related Definitions
Related Categories
Tip of the Day

Tip of the Day Pay All Credit Card Balances In Full Each Month

Pay All Credit Card Balances In Full Each Month - It is necessary to pay all credit card balances in full each month to prevent paying extremely high interest rates...

read entire tip

Related Podcasts
Recently Added
Other Great Sites

Capital Asset Pricing

Capital Asset Pricing MarginDate Added: May 16th, 2004

By Dan Schuster | E-mail


From the NFL draft to fast food value menus to Wall Street, the illusive term of "value" is used everywhere. By definition, something with a good value produces a high return in comparison to what you had to give up in order to acquire it. In terms of the stock market, investors are always trying to find stocks that are undervalued, meaning their current market price is less than what they are "really worth." The only problem is that it is next to impossible to determine the value of something until after its acquisition. For example, Ryan Leaf certainly wasn't a good value for the Chargers with the number 2 pick in the 1998 draft, and a stock with a low PE ratio can turn out to have terrible returns. So how does one determine the value of a stock? Simple...just call up the next psychic you see on one of those late night infomercials, or you could try using the Capital Asset Pricing Model (CAPM).

The CAPM is one of just many techniques that investors can use to find the intrinsic or real value of a stock. This model follows the basic premise that investors should be rewarded for taking excess risk, and that equities face two types of risk: market risk and unique risk. The CAPM only considers market risk in the valuation of securities because it is the risk associated with the movement of the entire market as a whole, and unlike unique risk, it cannot be diversified away.

Calculating Expected Return using CAPM

First, you need to find the beta of the security you are trying to value, which we will call security k in this example. You can usually do this by looking up a stock on Yahoo! Finance. Next, you simply plug the beta of k, noted by symbol Bk into the following equation:

ERk = rf + Bk (ERp - rf) where:

ERk is the expected return on the stock for the year

rf is the risk free rate of return

Bk is the beta of stock k

ERp is the expected return on the market portfolio (typically the S&P500)

While this may seem extremely complicated at first glance, it really isn't at all. In fact, Bk is the only real variable. The risk free rate of return, using the sensible assumption that the United States government won't default, is simply the return on a 30-year T-bond, which is typically around 6%. The expected return on the market portfolio can be estimated using the fact that the market has averaged a 12% return historically, or it can be estimated using analysts' estimates for the coming year. Thus, the equation simply becomes:

ERk = .06 + Bk (ERp -.06)

After you have calculated the expected return of the stock in question, it is very simple to make some conclusions as to whether or not you should invest in that stock. For example, if ERk < ERp, you may not want to invest in the stock because even if it will make you money, stock k will have a lower return than the market, and therefore, the money could be better invested elsewhere. On the other hand, investors should remember that a high expected return also implies a high risk of a negative so investors shouldn't rush into an investment based solely on the CAPM. Either way, it gives you a starting point in valuing the stock, and as Oscar Wilde stated in Lady Windermere's Fan, a cynic is "a man who knows the price of everything and the value of nothing."

Discuss It!
1 2 >

internet privacy said:

want to express my admiration of your writing skill and ability to make readers read from the beginning to the end .

bands for weddings said:

Pretty good post. I just stumbled upon your blog and wanted to say that I have really enjoyed reading your blog posts. Any way I'll be subscribing to your feed and I hope you post again soon. Big thanks for the useful info.

www.drsrecuperacaodedados.com.br said:

This particular publish is absolutely superb. I like this particular publish.

robinsonfps facelift atlanta said:

OPY World School is promoted and managed by Rao Mohar Singh Educat

christian detox centers said:

I am very glad it is now free to everyone. This is a decision that really helps to create more equality for everyone.

angeljackets.com said:

Iâve been reading book since college time.. Thatâs fascinated me and continued reading. From so many years, I have read blogs and editorials for the cause that they offer more information. Your story which you have written undeniable is an ideal example of what I wished-for. Visit angeljackets.com to get outfits that no other site or store has.

Clash of Clans Online Cheat Tool - COC HACK FREE GEM GENERATOR said:

Admiring the time and effort you put into your blog and detailed information you offer!.. said:

Thanks for sharing this interesting blog with us.My pleasure to being here on your blog..Iwannacomebeck here for new post from your site

garcinia cambogia said:

I don't grasp what has happened to the custom of passing on dependable awesome articles.

https://kaylaitsinesbbgblog.wordpress.com/2016/07/29/great-tips-for-losing-weight-and-finding-good-health-again/ said:

it will make you money, stock k will have a lower return than the market, and therefore, the money could be better invested elsewhere

label drucken lassen said:

Furthermore, accept that unmistakable perusers will also encounter how I feel in the wake of analyzing your article.

http://www.moviestarplanethackr.com/ said:

I may need to thank for the tries you have made in making this post.

pet waste stations said:

You brought up two or three things that I will recollect for a broad time assignment to come.

Exam Chacha said:

There is a significant measure of information here that can offer any business some help with beginning with a productive long range casual correspondence campaign !

http://anycreditcarloantoronto.ca/ said:

I am trusting the same best work from you later on as well. I anticipated that would thank you for this destinations !

buy instagram followers said:

You will locate an immense measure of approachs in the wake of going by your post.

nba live mobile hack said:

I am to a great degree playful to examine this article .. an obligation of appreciation is all together to give us experience info.

couchtuner said:

It is phenomenally important and to an extraordinary degree supportive and I truly took in a broad measure from it.

girlsdoporn said:

This is a wonderful stirring article.I am on an extremely essential level fulfilled by your astonishing work.

JBates said:

You will discover a great deal of approachs in the wake of taking off to your post.

Most Popular Articles
Most Popular Definitions
Daily Definition

Definition of the Day Coverage Ratio

Coverage Ratio - the term coverage ratio is a type of accounting tool that helps measure a company’s ability to survive and grow.  Simply by comparing the company’s assets (gross profits) and liabilities (expenses) are a form of figuring the coverage ratio. The higher the assets, and the lower...

read entire definition




Home     About Us    Contact Us     Contribute     Sitemap


Copyright © 2009 TeenAnalyst.com