Would you ever use CAPM to make personal investment decisions?
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Would you ever use CAPM to make personal investment decisions?
Note: the main message of the CAPM is the notion of diversification of investments. At least theoretically investors should only invest in two portfolios: one is the Market Portfolio (such as the S&P500 Index) and the other is a portfolio of short term or money market default-free securities.
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According to Investopedia.com, the Capital Asset Pricing Model (CAPM) "describes the relationship between risk and expected return and... is used in the pricing of risky securities." (Investopedia.com, 2007) The formula used for CAPM is shown below:
Ke= Rf +b(Km-Rf)
Ke= Cost of Equity
Rf= rate of return required on a risk free asset/ security/investment
Km= the required rate of return on the market portfolio
B= beta coefficient.
(Block & Hirt, 2005)
The CAPM prices individual securities or portfolios to determine expected return, and ...
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