The capital asset pricing model (CAPM) surges begins with the financial investment theory of William Sharpe (1964) and John Lintner (1965) that made them a highly valuable professional in the finance and business world for appreciation having owning a noble prize for Sharpe in 1990. This model is widely spread through out businesses to determine a possible theoretical appropriate measure in risky investments and to estimate the probable required return rate of an asset for decision making for a well-diversified portfolio.
There were no other CAPM like principles formulated during the time of Sharpe and Lintner to consider when it comes to investment opportunities that can clearly provide a fair trial on risk and return assumptions.
The capital asset pricing model has been popularly practiced by using it such as bases for cost of capital equity estimation of business firms and company management portfolio evaluation.
Some failing problems has been a concern when comes to its assumptions and predictions on the result of risk and expected rate of return. However, investment risk factors evolve that the logic of CAPM depends on any factors to consider and some professionals discover and improve the essence of CAPM in a market portfolio.
Presence of risk of investment in necessary to grasp CAPM intelligently. In the finance world, the CAPM model already provides a simple formula to calculate the expected return of an asset in a risky investment in the business portfolio. The formula for CAPM is composed of risk-free rate plus beta times the difference of the return on the market and the risk-free rate.
Expected Return= rf + b (rm-rf)
**rf- risk-free rate
**rm- return on the market
The CAPM model captures the heart of every business firms due to its appealing and captivating logic simplicity when it comes to theories on the expected risk associated on expected return of an asset.
CAPM numerous advantages is likely the reason why it is still popular and it cannot be entirely out of the subject in the business course lessons and its usage in investments decisions theory is very well known. But due to CAPM underlying assumptions, usage of CAPM should be well understand since its empirical problems can invalidate the use of its intended applications. The drawback of CAPM lies in the heart of the CAPM model itself due to volatility issue, unrealistic reflection of real-world picture in borrowing funds and the problem that you can accurately determine the and assess the reliability of the outcome.
Financial modeling in the finance world would can not surely provide the most accurate information and accurate income but like CAPM, some of its characteristics are useful and applicable. The theory and calculation of CAPM might guide you in your investment decision making and a reference in risk investment matters topic to be understand fully.