Research Articles Base: Capital Asset Pricing Model

How Satisfactory is Capital Asset Pricing Model as an Asset Pricing Theory?

How satisfactory is capital asset pricing model as an asset pricing theory?         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 asset’s non-diversifiable risk. (Wikipedia)       Only a person who understands what Capital Asset Pricing Model is can answer this question.  So we need to understand what CAPM is. Let me give you an example so that we can easily understand what is it all about?  Capital Asset Pricing Model has and why is it so popular theory that is being used all over the world in the arena of stock market? We are not going into the technical difficulty of its depth but we are going to discuss its theory and system in laymen’s term so it can be easily understood.       Let us say that you have a 00 U.S. Dollars at hand and you would like to invest it in something worthwhile, you may then go out to plan and look for ways how you can place you money for the purpose of investment. At first you have found a bank that offers you  4% risk free interest, it is risk free since the government will provide a guarantee for your money whatever happen to the bank if ever there has been a bankruptcy they will still pay for your money. Will you invest your money? Think about it. Let us say another business person have urge you enter in their business of selling ready to wear clothes rather than invest you money in the bank which only offers a risk free but a low 4% interest rate. This business person says he will give you a 10% interest if you invest your money in his business. You may thought about the weak sales is a risk on your part and so it maybe since the sales of a ready to wear clothing may vary from time to time this person may not be able to pay you in time so there is a slight risk in your savings. But then again you may think about the 10% offer which is more than double of 4% interest in bank offer. A slight risk is there and you may think about it deeper if you are going to accept the businessman’s proposal.       Now, another business person has offer a partnership of a new business let us say you are going to engage in a computer shop business. This business offers you 30% shares of over all income if you are going to invest your money in his newly constructed computer shop. You may think about the risk of its sale, you may wonder if he will find a good location in his business or will he ever earn since he is new to the market. The big risk is there but a good earning potential also exist. Would you accept his offer?        And so you have 3 offers on your part at hand and this are the following: 1.    Bank                                       at 4%    risk free 2.    Ready to wear business         at 10%  medium risk or systematic risk 3.    New computer shop               at 30%  high risk       What offer will you accept is up to you. Let us go back to the Capital Asset Pricing Model and let us represent the following it its use, let say you are looking for an equity represented by equity=Ke and the bank offer is risk free = Rf  and the market rate is =Rm and  β= medium risk or systematic risk.  We can derive the following formula: Ke= Rf + β (Rm-Rf) Since we are just talking about the theory we are not going to dig into the deeper computation of the following but you already have in your mind the idea of the system. And this is just one example of a formula using the theory of Capital Asset Pricing Model, from this point of view we can easily determine what lost or gain we can derive from the recent three offers.  This model is used as a tool to determine if an asset or investment will give us a reasonable expected return or risk. From the following example we can say that the Capital Asset Pricing Model is a very satisfactory theory that will give us an advance and updated knowledge to be wise in making decisions in making a good investment.                                                                                                                                       Credit:ivythesis.typepad.com

How Satisfactory is Capital Asset Pricing Model as an Asset Pricing Theory?

How satisfactory is capital asset pricing model as an asset pricing ...

Diversification Reduces Risk

THE IMPORTANCE OF DIVERSIFICATION         In a company diversification is very important especially in risk reduction management system’ for instance; financial integration and or financing capital, capital allocation and many other marketing practice. Diversification aims to maximize potential investment or a quick return of investment for newly established businesses. It also aims to minimize risk in order to accomplish goals and market adaptability depending on company’s situational position. If a certain company would not adapt such diversification process possibility of closure is at hand. A company whose financial position of capital allocation is stagnant may also have the same position of shut down because of lack of resources of financial outcome. The Capital Asset Pricing Model has introduced this kind of risk reducing scheme to revolutionize the theory of investing which focuses on the option of investment.       What if a person or business do not assume diversification or do not have the capacity to diversify; let us see an example – A certain doctor who earned thousands of dollars in his profession invested all his money in one distribution multi-level and networking company who happened to be a leader in food and herbal production. Because of his confidence in the business he continuously gains expectation that his investment will continue to grow and so it does. But one time the government has put restriction on the business for non compliance in material acquisition, to make the story short this business left the country to migrate and the doctor has not been able to get his dividend on the business. This experience taught him a lesson to diversify his investment to reduce the risk of same awkward position.             There are many reasons why diversification should be practice even to a small and medium established businesses, to demonstrate a situation of diversification in an actual scenery in business let us introduce some companies who uses this technique;       If you are going to put your investment in a well known bank let’s say Metro Bank you are guaranteed that you eliminate the risk of 100% since Metro bank is a stable company and even if the bank declared an unexpected bankruptcy the government insurance policy will still assure your investment but then again the interest rate would be more or less than 5% of your investment. So to diversify you can divide your investment to a bank plus other businesses that offers a higher interest rate such as stocks, bonds, or partnership of existing business leaders although risk maybe higher but can be favorable like the example below;         Nestle the world leader in food distribution have partners of stock brokerage from around the world in most countries. In the Philippines they penetrate the market by merging to San Miguel Corporation their stocks for more than fifty years. During the early years of 2000 both companies decided to end their partnership. San Miguel sold their stocks to Nestle and thereby both companies experienced a win situation since Nestle have gain solidarity in management as well as market acceptability while San Miguel Corporation have additional capital stocks for their business. Such diversification has created both parties to gain more strength and stability. They have presumed an assumption of convergence before parting ways so as to reduce and basically eliminate the risk involve during their partnership.       BMW in Japan that produces luxurious automobiles was heavily affected by the recent Earthquake, the production flow was hampered and the danger is still there. If they have not promoted a diversified tactic the BMW business may result in company shut down. The diversified technique they use is to still produce parts of automobile and import these to other countries. Some automobile are sold at auction or a lower price. They may have not gain stable sales during these times of crisis but they have eliminated the risk of total insolvency.       Remember though that no matter how diversified your portfolio is, risk cannot be thoroughly eliminated. Risk will always be there depending on the circumstance but to be able to assume clearly and define your goal clearly in diversification you are guaranteed you have already performed your duty. In layman’s term the simplest example of diversification is provided by the proverb “don’t put all your eggs in one basket”. Dropping the basket will break all the eggs. Placing each egg in a different basket is more diversified. There is more risk of losing one egg, but less risk of losing all of them.                                 Credit:ivythesis.typepad.com

Diversification Reduces Risk

THE IMPORTANCE OF DIVERSIFICATION In a company diversification is very important especially in risk reduction management system’ f...

Capital Marketing Theory

CAPITAL MARKETING THEORY         The Capital Marketing is about making decisions whether you would be engaging into any types of plan like Investment, Retirement or Financial Plan. Capital Marketing Theory therefore is the new version or a shift of Capital Asset Pricing Model (CAPM) which focuses on risk and returns while in the Capital Marketing represent a new theory of deeper thinking a new approach, since the marketing supply and demand has been constantly changing.       This theory is also about raising funds, a trade of financial capability or simply selling securities in order to raise funds where stock and bonds is a part of it. A company who sells the securities is open to the general public who wish to buy a part of it, the buyer will invest their money and in return they will earn in the form of dividend or interest according to the company performance. The primary role of Capital Market is to bridge the needs of company who are running or needing additional resources and investors who have the capacity to allocate their resources by sharing their capital to the company who needs it. Both of them have a mutual desire to expand profitability over others; this has been a win-win partnership in disguise.         Company’s source of funds can be gained through Capital Market in a long term investment that they can use to expand their business, the Capital Market they have gained are a joint complimentary from the buyers investment and therefore the investors is silently a part of the company. The company has the right to sell their shares the same with the investors if they like to. One of the most popular Capital Market trading is the India’s Capital Market which attracted more than 30 Million investors.        Capital Market has been widely practiced all over the world through Securities and Exchange Commission who has the control over the transaction between the buying public and the selling companies. The SEC is also the agency who can protect the investors against deceitful and fraudulent companies who gather funds for illegal purposes.            For now you may ask how the Capital Market works in a certain company it maybe a little bit confusing and hard to understand for a first time investors so we are going to simplify how the Capital Market works through examples and it goes like this. Let us presume that I have created a business in the clothing industry line where I have gained a customer’s response of an overwhelming ratio over the competition, during the start of my business I have bought at least fifty (50) sewing machine, a piece of land and constructed a building as a depot or factory to stock the merchandize. I have also contracted at least seventy five (75) employees to work on my factory, therefore I have invested at least USD10 million dollars to start my business.      During my first year of operation my distribution is somehow stable and my sales are a bit slowly gaining its strength. But the production continues and the prices of raw materials continue to increase due to inflation. I will be needing another USD 5 million dollars. What I am going to do to maximize profitability of my business is to go to the Securities and Exchange Commission to enroll my business to look for investors who are willing to engage themselves to invest with me. If investors have found the possibility of my portfolio they will invest in my company but a single individual do not have that much money, in a Capital Market a person can engage in an investment even if they only share a portion of what they have. Let’s say the investor would want to invest only the amount of USD 10,000 dollars, this may be acceptable since I will look for another investor continuously to reach my goal or probably exceed much more than I want. Their investment will be called stocks.       The money that I have gathered will go directly to the investment of new machineries and distribution channels for expansion and in return when our money grows, the investors will be having a share of income that they will receive monthly or bi monthly which is called dividend or interest, they will also  have the rights to join and participate in some ways to the company if they want to by joining some events or stockholders meetings so they can participate in policy making or they can even choose to vote the new leaders. We will be both happy about our investment. If there will come a time that they are not happy about their income they are free to sell their stocks and the cycle goes for my business to continue to look for another investors. There is so much to discuss about stocks but this simple example should be enough to understand what Capital Marketing is all about.             Credit:ivythesis.typepad.com

Capital Marketing Theory

CAPITAL MARKETING THEORY The Capital Marketing is about making decisions whether you would be engaging into any types of plan like...