Determining An Investment’s Fair Value: Capital Asset Pricing Model

In every investment, some risks cannot be ignored nor are impossible to get rid of. Any investor, whether individuals or corporate, strive to achieve a rate of return that can recompense for the risks that come with it.

Business Acronym CAPM – Capital asset pricing model.Yellow paint line on the road against asphalt background. Conceptual image

Image source: 123rf.com

The capital asset pricing model (CAPM) was formulated to help calculate investment risks that can be categorized into two types: systematic risk and unsystematic risk. Systematic risks are those that cannot be solved through diversification, for example, interest rates, wars, and recession. Unsystematic risks are specific to the investment that are not correlated or caused by general market movement.

CAPM takes into consideration various factors in determining inherent risk levels and expected return on investment. These include the rate of return for a risk-free security, the market premium, and the sensitivity or relative volatility of the investment calculated by a third party.

While CAPM is a rather simple theory, it has helped those in the investment community by providing a way to learn how individual stocks might behave depending on particular market movements. The portfolio can be safely tailored to the specific risk-return requirements.

CAPM is also used to find out what an investment’s fair price ought to be. The capital asset’s rate of return calculated through CAPM can be used to discount the investment’s cash flow in the future compared to the present value to arrive at its fair value.

Capital Asset Exchange and Trading (CAE), headed by its CEO Ryan Jacob, conducts deep financial and operational due diligence on prospective investments, and structuring and executing a wide range of contemplated and completed transactions. Learn more about the company by visiting its official website.

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