Capital Asset Pricing Model (CAPM)

The capital asset pricing model (CAPM) is a mathematical model that explains the relationship between investment risk and return. The asset value can be determined by dividing the covariance of the revenue of the asset by the variance of the market. An overall assessment of the market is conducted to determine the level of risk for a particular asset. Unlike the DCF model, the time value of money is not taken into account. In this model, investors understand the risks involved, and we assume that there is no need to exchange for costs.

Another Nobel laureate winner, William F. Sharp, extended Marcoits' research and led the notorious capital asset pricing model (CAPM). In this article I will not look into this model in detail. However, I will use one of his contributions (Sharpe ratio) as a criterion for choosing this "best combination". The Sharpe ratio is only indicative of the return risk of investment performance. This ratio adjusts the return on investment so that you can compare investments with different risk sizes. Without the size of such a comparison it is almost impossible to compare various investments and various combinations and the risks and rewards associated with it.

Based on the work of Harry Markowitz, John Lintner, William Sharpe, and Jack Treynor are usually given a great deal of credit to introduce the capital asset pricing model (CAPM), the first formal asset pricing model . It was developed in the early 1960s and provides the initial precise definition of risk and how it produces the expected return. CAPM focuses on risks and returns from a "single factor" point of view. Portfolio risks and returns are determined only by risk to market beta. Beta is an indicator of the risk of equity, investment trust, or portfolio stock type against overall market risk. CAPM is a sales model of the financial industry for about 30 years.