Evaluation of Analysis Measures
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For an organization owning multiple assets where their core business is not real estate is CAPM recommended to use or not for measurement as a good indicator of an assets performance? Why or why not?
How do,
- Risk-free rate of return
- Beta (as a risk measure)
- Expected market risk premium
affect this?
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Solution Summary
The solution decides if CAPM is a good indicator of asset performance for an organisation with multiple assets. It also speaks on the influence of a risk-free r.o.r., beta, and expected market risk premium to that measure.
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The capital asset pricing model (CAPM) is expressed as follows:
ER = Rf + Beta * RP
Where
ER is the required return to the asset,
Rf is the risk free rate of return,
RP is the market risk premium, and it is equal to the expected market return rate minus the risk free rate (ERm - Rf)
One important contribution of the CAPM is the inclusion of the systematic risk (measured by Beta), which cannot be eliminated through diversification. Given that both the risk-free rate of return and the market risk premium are exogenous, or unrelated with the specific asset, its required return rate mainly depends on its systematic risk.
However, the CAPM is often ...
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