# CAPM Flashcards

What is the formula for expected return?

Rf + β(Rm - Rf)

Rf = risk free rate

Rm = Expected market return

β = measure of risk

What is risk free rate?

The return on a hypothetical investment with no risk

What is the required return formula?

Rf + RP

Rf = risk free rate

RP = risk premium

What is the Expected return formula?

WfRf+WmE(Rm)

E = expectation operator

Rp = return on portfolio

Wf = share of risk free asset in portfolio

Rf = return on the risk free asset

Wm = share of market portfolio in portfolio

Rm = return on the market portfolio

What is unsystematic risk?

Unique risk

What is systematic risk?

Market risk

What does σ mean?

standard deviation

What does β mean?

Measures the covariance between the returns on a particular share with returns on the market as a whole

If β is 1 then:

A 1 percent change in the market index return generally leads to a 1 percent change in the return on the share

if 0 < β < 1 then:

A 1 percent change in the market index return generally leads to a less than 1 percent change in the returns on a specific share

If β > 1 then:

A 1 percent change in the market index generally leads to a greater then 1% return on a specific share

What are 2 applications of CAPM?

- Investment in financial markets

- Calculating the required rate of return on a firm’s investment projects

What are some unrealistic assumptions of CAPM?

- Investors are rational utility maximisers
- Information is freely available
- Investors can borrow and lend at the risk free rate
- Capital markets are perfectly competitive and frictionless
- Securities are infinitely divisible