CAPM Assignment Example | Topics and Well Written Essays - 1000 words

CAPM - Assignment Example CAPM has theoretical limitation, which include impractical assumptions and instability of the beta values. The Arbitrage Pricing Model and Rolls have criticized the theory indicating that it may be unreliable and invalid. This study will examine the theoretical limitations and criticisms of the theory. Theoretical Limitations of the Theory The theory argues that all investors are risk avoiders and that the returns are normally distributed (Ma, 2011). This is not the case because investors are normally risk takers who are willing to make huge returns when their predictions favor them and lose when they fail. Assuming that returns are normally distributed is also unfounded because investors are not usually sure of the yields on their assets (Ma, 2011). The assumption that assets are free from risk is also unrealistic because it is hard to find such stocks in the real world. The theory argues that short-term securities offered by the government are free from hazards because the state as sures investors certain returns on the assets. This is not the case because the risk on the assets is in the form of inflation, which is the instability of prices in the market (Ma, 2011). Inflation leads to the loss of value of money, and this means that, assets also lose their worth when prices rise in the economy. Since money loses its value then it means that investors face the risk of lower returns when their stock matures. For example, when the state pays 10% on its short-term bonds then inflation rises in the country by 2%, investors get 8% returns on their securities in real terms. This means that investors face the risk of inflation, which reduces their earnings. This also indicates that the CAPM model is applicable in an ideal world, an occurrence that is impossible (Ma, 2011). Roll’s Critique of CAPM Roll criticizes the validity of the Capital Asset Pricing Model equation. The equation is as indicated below: E(Ri) =RF +?i [E(RM) - RF] Where E(Ri) represents the yie ld on security i. RF is the risk free rate of return. Bi is the market risk that security i faces. Roll’s first critique was that the model could not be tested using current data because it is constructed based on historical data. The impossibility of testing the model arises from the fact that it is based on market values of stocks, real estates, jewelers, and labor. Rolls argue that it is impossible to find the market value of this portfolio because no accurate data of these factors exists in reality. Thus, Roll argues that the CAPM cannot be proven right or wrong because of the impossibility of getting accurate data (Ma, 2011). Roll argues that economic models should be easy to test using future data because they simplify the real life. However, according to him, CAPM is complex because of the inability of being tested using future data, and this makes it unreliable. Roll also postulates that it is impossible to get efficient stocks whose values and rates of return have li near relationships ideally (Ma, 2011). Therefore, Rolls argument generally argues that CAPM is unreliable because it has never been tested using real data, and it is still impossible to do so because of uncertainty of prices, which is common in the real world. Arbitrage Pricing Model (APM) The APM addresses the weaknesses of CAPM by doing away with the assumption that the

Financial Management and Policy Essay Example | Topics and Well Written Essays - 3000 words

Financial Management and Policy - Essay Example 6.0 Key Drivers of Change 13 7.0 Conclusion 13 Reference List 15 EXECUTIVE SUMMARY: "Realistically, the contested takeover, the proxy contest and institutional shareholder activism may be the only means for forcing ineffective management out and getting better utilisation of corporate resources" - James C. Van Horne (2002). Moreover the ever-present threat of these things may stimulate the existing management to perform better. However no other dramatic or controversial activity can happen in the corporate history than the acquisition of one firm by another or the merger of two firms. There are different opinions and schools of thoughts concerning these important happening in the corporate world, with respect to the definitive advantages and disadvantages that may accrue both to the acquiring firm as well as the firm that is being acquired. This study paper envisages to bring out the details of one of such proposals for a well publicized acquisition deal among two corporate giants, NTL, an American based Telecom and cable services giant and ITV, one of the biggest B ritish television content producer, with specific reference to the strengths and weaknesses of both involved in the deal, the underlying reasons for NTL to take such a strategic move along with the various other factors affecting the proposed acquisition deal and the key factors responsible for such a move and of course a final...This study paper envisages to bring out the details of one of such proposals for a well publicized acquisition deal among two corporate giants, NTL, an American based Telecom and cable services giant and ITV, one of the biggest British television content producer, with specific reference to the strengths and weaknesses of both involved in the deal, the underlying reasons for NTL to take such a strategic move along with the various other factors affecting the proposed acquisition deal and the key factors responsible for such a move and of course a final dialogue on the expected reactions of the individual firms and the corporate world as such over the merger . The market for corporate control can alter dramatically the setting in which business firms compete. In an idealised world this market is a positive thing for the stockholders and the economy as a whole. Assets, people and products may be transferred to more productive uses. With rapid changing technology and product markets what was once a viable corporate strategy may no longer be so.