Capital Asset Pricing Model Flashcards
How is the investment risk split?
Unsystematic risk
Systematic risk
What is unsystematic risk?
The risk which is unique to each company’s shares. Can potentially be eliminated
What is systematic risk?
The risk which affects the market as a whole rather than a specific company’s shares. Can’t be eliminated
How to calculate the total risk?
The sum of systematic risk and unsystematic risk
Why do supermarkets have a relatively low risk?
People will always buy food, regardless of the state of the economy
Why do tour operators have a relatively high risk?
During a recession, demand for holidays will fall.
What is a beta value?
An index of responsiveness of the returns on a company’s shares compared to the returns on the market as a whole
How are beta factors for quoted shares measured?
Using historical data and published in “beta books”
When beta = 1?
Indicates a “neutral” share that is as sensitive as the market to systematic risk. Such shares should earn the market return.
When beta > 1?
Indicates an “aggressive” share that is more sensitive than the market
When beta < 1?
Indicates a “defensive” share that is less sensitive than the market and is likely to rise and fall in value less than the market in genera
What is CAPM?
Calculating the return required on an investment, based on an assessment of its risk
What is the security market line?
Graph which plots the required return (E(ri)) from any investment according to its systematic risk, as measured by its beta
What is a positive alpha investment in SML?
Any share with a return above the SML’s forecast to earn higher returns than predicted by CAPM for its beta
What is a negative alpha investment in SML?
Any share with a return below the SML would be sold as it appears to be temporarily overpriced.
