Disscuss the relevance of the capital asset pricing model (CAPM) to a Essay - 2

Disscuss the relevance of the enceinte asset pricing model (CAPM) to a company seeking to evaluate its cost of capital - Essay Example(Burton, 1998)The CAPM had its origin from the model of portfolio choice developed by Harry Markowitz. In the model, an investor is assumed to decide on the investment portfolio at clock time t-1 with an expected return at time t. Since the investors are assumed to be guess averse, the data that they care about are the mean and the variance of their angiotensin-converting enzyme period investment return. As a result, investors choose mean-variance-efficient portfolios, in the sense that the portfolios 1) minimize the variance of portfolio return, given expected return, and 2) maximize expected return, given variance. Thus, the Markowitz draw close is often called a mean-variance model (Eugene F. Fama).This figure gives a clear picture of the CAPM. Its horizontal axis shows the portfolio risk which is measure by the standard deviation of portfolio return. Its erect axis is the expected return. The curve is the minimum variance frontier which traces the combination of expected return and variance at different levels of expected return (Eugene F. Fama). This shows the unadorned trade-off between risk and expected return.At point T, the investor can have an intermediate expected return with lower volatility. If there is no risk free borrowing or lending, only portfolios above b along abc are mean-variance-efficient, since these portfolios also maximize expected return, given their return variances (Eugene F. Fama).EM applications. (2009). Capital Asset Pricing Model (CAPM). Emapplications.com. Available from November 16,