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What is Capital asset pricing model?

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What is Capital asset pricing model?

Capital asset pricing model formula4
 

What is Capital asset pricing model?

The capital assets pricing model (CAPM) favors a form to calculate the expected payback of an asset-based on the period value of money and the risk of systematic investment. It is basically used in funds to price the risk of MSME Collateral3 and return on that investment when seeing the cost of capital and the risk.

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Risks are of two types:

• Systematic risk, and  

• Unsystematic risk

Systematic risk is also known as market risk. It is essential to the market exclusively.

Systematic risk consists of:

  • Interest rate risk
  • Exchange rate risk
  • Purchasing power risk
  • Market risk

Unsystematic risk is also known as specific risk and diversifiable risk. It is an uncertainty of financing in the industry.  

  • Unsystematic risk consists of:
  • Financial risks, and
  • Business risk
  • Given below is the formula of Capital Asset Pricing Model

ERi = βi(ERm-Rf)

Where,

 ERi = return of the investment

 Rf = risk – free rate

 βi = beta of investment

ERm = return of the market

(ERm – Rf) = to calculate the market risk premium, we have to subtract the risk-free rate from the expected return of the investment.

The advantages of CAPM involve the accounts of systematic risks and it can be understandable and can be used easily.

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