Posted: January 4th, 2017

Does CAPM provide a good account for pricing a firm’s debt or equity?

‘The Capital Asset Pricing Model (CAPM)’ has dominated academic literature and greatly influenced the practical world of finance and business for almost half a century; as a way to measure systematic risk. Researchers in the 1980s and 1990s have questioned the relationship between systematic risk, measure beta, and returns on securities. Despite heavy criticism of the model from the academic community, CAPM has reached new heights of popularity in the outside world (Arnold pp 269). Hundreds of thousands have studied the CAPM in universities and now hold key positions ready to make decisions based on the model. Does CAPM-beta really provide the answer to the risk-return relationship? Does CAPM provide a good account for pricing a firm’s debt or equity? Hence is CAPM of relevance to corporate managers? Explain and discuss this contention.This assignment relates to the portfolio theory and the capital asset pricing model. To answer it satisfactorily, you will need to give some thought to the question and to discuss the relationship between risk and return, define the fundamental features of the capital asset pricing model and discuss the empirical evidence relating to the CAPM. The main body of the report should focus on why the academic community are turning away from the CAPM. The latter part of the question requires more thought, and you should try to highlight features of the CAPM which lends itself to the context of corporate managers. In the development the answer you are expected to include relevant economic and financial concepts and where appropriate and use relevant diagrams.

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