One of the starkest contrasts in finance is found in comparing the elegance of capital-asset pricing theory with the coarseness of its application. Although the capital-asset pricing model (CAPM) is well understood, the theory says nothing about which risk-free rates, market premia, and betas to use in the model. Possibilities abound, and any sampling of academicians and practitioners will summon up many combinations and permutations of methods. Rather than use all approaches, these notes cling to two:

Short-term risk-free rate and arithmetic market premium: The argument for this approach is that short-term rates are the best proxy for riskless rates: as obligations of the U.S. (or other) government, short-term rates are the closest to being default-risk free. As short-term rates, they suffer little risk of illiquidity or capital loss because of sudden rises in market yields. For the purposes of these notes, “short term” is defined as 90 to 360 days. The corresponding market premium used is the arithmetic average premium estimated over the long term (e.g., 1926 to the date of the case). For the period through 1992, this average was estimated to be 8.6 percent.2 If there is a bias in academia and in practice, it is toward the arithmetic premium, because, when compounded over many periods, an arithmetic mean return is the one that gives the expected value (i.e., mean) of the probability distribution of expected ending values.

Long-term risk-free rate and geometric-mean market premium: Partisans of the long-term risk-free rate argue that most corporate investments are for the long term and that the long rate better matches the term of the asset being valued. According to this view, investors want to earn a market-risk premium equal to the compound rate of return (over time) that the stock market has earned over and above returns on long-term bonds. For the purposes of these notes, “long term” is...

...the three most common models used for estimating the rate of return for a given company; dividend growth, Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT).
The board of directors for Apple Computer Corporation will receive this report, and based on the findings and analysis included, Apple will be given a recommendation as to the costequity model they should implement to estimate their future rate of returns.
This report...

...
Equity
In accounting and finance, equity is the residual value or interest of the most junior class of investors in assets, after all liabilities are paid; if liability exceeds assets, negative equity exists. In an accounting context, shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the remaining interest in the assets of a company, spread among...

...Cost of equity refers to a shareholder's required rate of return on an equity investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk.
How It Works/Example:
The cost of equity is the rate of return required to persuade an investor to make a given equity investment.
In general, there are two ways to determine cost...

...CAPMCAPM provides a framework for measuring the systematic risk of an individual security and relate it to the systematic risk of a well-diversified portfolio. The risk of individual securities is measured by β (beta). Thus, the equation for security market line (SML) is:
E(Rj) = Rf + [E(Rm) – Rf] βj
(Equation 1)
Where E(Rj) is the expected return on security j, Rf the risk-free rate of interest, Rm the expected return on the market portfolio and βj the...

...
The Capital Asset Pricing Model commonly known as CAPM defines the relationship between risk and the return for individual securities. CAPM was first published by William Sharpe in 1964. CAPM extended “Harry Markowitz’s portfolio theory” to include the notions of specific and systematic risk. CAPM is a very useful tool that has enabled financial analysts or the independent investors to evaluate the risk of a specific investment while...

...pricing model (CAPM)
Using the Capital Asset Pricing Model, we need to keep three things in mind. 1 there is a basic reward for waiting, the risk free rate. 2 the greater the risk, the greater the expected reward. 3 there is a consisted trade off between risk and reward.
In finance, It is used to determine a theoretically appropriate required rate of return of an asset, if that asset is to be added to an already well-diversified portfolio, given that asset's...

...|
Table of Contents
Cost of Capital 2
Value of Equity 2
Cost of Equity 2
CAPM Model 2
Dividend Growth Model 3
Value of Debt 3
Cost of Debt 4
WACC (Weighted Average Cost of Capital) 4
Comparison to Joanna Cohen’s Analysis 4
Financial Statement Analysis 5
Nike Inc. 5
Financial Ratios 6
Leverage Ratios 6
Efficiency Ratios 6
Liquidity Ratios 7
Profitability Ratios 7...

...CAPM
1 Calculate the expected return for A Industries which has a beta of 1.75 when the risk free rate is 0.03 and you expect the market return to be 0.11.
2 Calculate the expected return for B Services which has a beta of 0.83 when the risk free rate is 0.05 and you expect the market return to be 0.12.
3 Calculate the expected return for C Inc. which has a beta of 0.8 when the risk free rate is 0.04 and you expect the market return to be 0.12.
4 Calculate the expected...

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