Important Points for IC 99 - Asset Management Exam
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In portfolio theory and portfolio management, the capital asset pricing model (CAPM) is used to determine appropriate required rate of return of an asset to make decisions about adding assets to a well-diversified portfolio. This model describes the relationship between systematic risk and expected return for assets, particularly stocks.
The CAPM is a model which is used for pricing an individual security or portfolio. For individual securities, it makes use of the security market line (SML) and its relation to expected return and systematic risk (beta) to show how the market must price individual securities in relation to their security risk class. The CAPM formula is E(R?) = R_f + ?? {E (R?) - R_f}
The CAPM model signifies that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken.
System risk represented by beta is a market related component of portfolio risk.
CAPM provides a conceptual framework for evaluation of any investment decision through proper analysis and estimation of risk and return.
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