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CAPM IPCC

Nihar (IPCC) (566 Points)

24 April 2011

this CAPM topic of cost of capital is going..TOTALLY BOUNCER.....!!!

can anybody explain me...in simpal words here...!!

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CS LLB Pulkit Gupta (https://www.facebook.com/pages/Life-and-Promises/553962034682487) (16631 Points)
Replied 24 April 2011

Ok lemme try. First let us start from the formula :-

This model describes the relationship between risk and expected return and that is used in the pricing of risky securities.

Tum investor ko point of view so socho. Tum kahin apna hard earned money invest karte ho to uske badle tumhe return milta hai. Kam risk wali jagah invest karoge toh kam return milega par agar uss security mein invest karoge jisme risk jyada hai to return bhi jyada hoga.

Ab ek Co. tumhe tumhare investment ke liye 2 tarah se compensate karegi. Pehla toh tumne unki security mein paisa fasaya hai(comes time value of money) aur iske liye minimum return jo kisi Govt. security mein milta minimum utna deke compensate karega par unhe tumne jo risk liya hai uske liye bhi compensate karna hoga.

Translation in English:-

The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to the market premium (Rm-rf).

The CAPM says 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. The security market line plots the results of the CAPM for all different risks (betas).

Using the CAPM model and the following assumptions, we can compute the expected return of a stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)).

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