In finance, the capital asset pricing model (CAPM) is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that assets non-diversifiable risk. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.
The model was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965a, b) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton Miller jointly received the Nobel Memorial Prize in Economics for this contribution to the field of financial economics.
The CAPM returns the asset-appropriate required return or discount rate—i.e. the rate at which future cash flows produced by the asset should be discounted given that asset's relative riskiness. Betas exceeding one signify more than average "riskiness"; betas below one indicate lower than average. Thus, a more risky stock will have a higher beta and will be discounted at a higher rate; less sensitive stocks will have lower betas and be discounted at a lower rate. Given the accepted concave utility function, the CAPM is consistent with intuition—investors (should) require a higher return for holding a more risky asset.
Since beta reflects asset-specific sensitivity to non-diversifiable, i.e. market risk, the market as a whole, by definition, has a beta of one. Stock market indices are frequently used as local proxies for the market—and in that case (by definition) have a beta of one. An investor in a large, diversified portfolio (such as a mutual fund), therefore, expects performance in line with the market.
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Table of Contents of Project Report:
CHAPTER 1: INTRODUCTION
1.1 CAPITAL ASSET PRICING MODEL (CAPM)
1.2 LIMITATIONS OF THE CAPM
1.3 THE CLASSIC SUPPORT OF THE THEORY
1.4 CHALLENGES TO THE VALIDITY OF THE THEORY
CHAPTER 2: LITERATURE REVIEW
CHAPTER 3: THEORETICAL FRAMEWORK
CHAPTER 4: RESEARCH METHODLOGY
4.1 RATIONALE OF THE STUDY
4.2 STATEMENT ABOUT THE PROBLEM
4.3 OBJECTIVES AND SCOPE OF THE STUDY
4.4 NEED OF THE STUDY
4.5 RESEARCH DESIGN
CHAPTER 5: DATA ANALYSIS
APPENDIX 1: THE SOURCE OF DATA