CAPM and the use of it Essay Example | Topics and Well Written Essays - 1500 words

CAPM and the use of it - Essay Example Capital asset pricing model delivers a very simple and easy theory. It offers an utilizable measure to calculate risk that facilitate financier to find out that how much return they are going to get for putting their funds at risk. This model mainly targets the risk averse investors. Capital asset pricing model is the widely used and mainly preferable model for risk and return used in finance. CAPM specifies the association between the risk and expected return that an investor gets on asset. This model is basically used to determine the expected required rate of return on assets and to determine the price of risky securities in the portfolio. This is the model in which securities are priced in such a manner that investors get compensation for the risk involved in the security by offering them return. Systematic risk is the market risk and the one that cannot be diversified easily or that can totally out of range to diversify away. It includes wars, an unpredictable variation in interest rates and many other macro economic factors. Unsystematic risk on the other hand involves those which can be sort out easily because this type of risk is related by means of the individual or stock an investor has in his portfolio. This is also identified as specific risk. This risk is not exposed to in general as a whole. An investor can diversify away unsystematic risk by raising the figure of stocks in his portfolio. So in technical words it can be stated that unsystematic risk does not move with the market as a whole. According to Modern Portfolio theory, it is concluded that unsystematic risk can be diversified but systematic risk still one of the troubles for the investors which cannot be ignored. So here the capital assets pricing model fully fitted and solve the problem because it is applicable for both type of risk either systematic or specific by diversifying it. CAPM itself exposed to some factors that are prevailing within capital