NAME OF THE PROJECT WRITE A SHORT NOTES ON CML, CAPM, BETA, SML AND WRITE IMPLICATION ON IT.

NAME &ADDRESS OF COGELLE SMT. JANAKIBAI RAMA SALVI COLLEGE OF ARTS, COMMERCE & SCIENCE MANISHA NAGAR, KALWA (W), THANE-00 605 NAAC ACCREDITED B GRADE STANDARD: T.Y. BANKING &INSURANCE

ACADEMIC YEAR: 2013-2014

GROUP NO.6
GROUP NAME REKHA YADAV SUMAN SONKAWDE ASHWINI CHAKAR BHAGYASHREE PALE HEMLATA SALUNKE ROLL NO. 54 47 05 33 42

DECLARATION
I hereby declaration that the information / date prepared by me and not copied from any text book, articles, journals published and internet etc.

Capital asset price model (CAPM)

The CAPM was introduced by Jack Treynor (1961, 1962), William Sharpe (1964), John Lintner (1965a,b) and Jan Mossin (1966) independently, building on the earlier work of Harry Markowitz on diversification and modern portfolio theory. Sharpe, Markowitz and Merton Miller jointly received the Nobel Memorial Prize in Economics for this contribution to the field of financial economics. Because of its simplicity and despite more modern approaches to asset pricing and portfolio selection (like Arbitrage pricing theory and Merton's portfolio problem, respectively), CAPM is still enjoys popularity. An economic theory that describes the relationship between risk and expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification. The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security plus a risk premium multiplied by the asset's systematic risk. Theory was invented by William Sharpe (1964) and John Lintner (1965). The early work of Jack Treynor is was also instrumental in the development of this model.

A model that attempts to describe the relationship between the risk and the expected return on an investment that is used to determine an investment's appropriate price. The assumption behind the CAPM is that money has two values: a time value and a risk value. Thus, any risky asset or investment must compensate the investor for both the time his/her money is tied up in the investment and the investment's relative riskiness. This compensation must be in addition to the risk-free rate of return. There are a number of variations on the CAPM, notably the multifactor CAPM and the two-factor model. The CAPM is calculated according to the following formula:

Beta is a measure of an investment's relative volatility. The higher the beta, the more sharply the value of the investment can be expected to fluctuate in relation to a market index. For example, Standard & Poor's 500 Index (S&P 500) has a beta coefficient (or base) of 1. That means if the S&P 500 moves 2% in either direction, a stock with a beta of 1 would also move 2%. Under the same market conditions, however, a stock with a beta of 1.5 would move 3% (2% increase x 1.5 beta = 0.03, or 3%). But a stock with a beta lower than 1 would be expected to be more stable in price and move less. Betas as low as 0.5 and as high as 4 are fairly common, depending on the sector and size of the company. However, in recent years, there has been a lively debate about the validity of assigning and using a beta value as an accurate predictor of stock performance.

Beta:
The measure of an asset's risk in relation to the market (for example, the S&P500) or to an alternative benchmark or factors. Roughly speaking, a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [More precisely, that stock's excess return (over and above a short-term money market rate) is expected to move 1.5 times the market excess return).] According to asset pricing theory, beta represents the type of risk, systematic risk, that cannot be diversified away. When using beta, there are a number of issues that you need to be aware of: betas may change through time; betas may be different depending on the direction of the market (i.e. betas may be greater for down moves in the market rather than up moves); the estimated beta will be biased if the security does not frequently trade; the beta is not necessarily a complete measure of risk (you may need multiple betas) Also, note that the beta is a measure of co-movement, not volatility. A measure of a security's or portfolio's volatility. A beta of 1 means that the security or portfolio is neither more nor lessvolatile or risky than the wider market. A beta of more than 1 indicates greater volatility and a beta of less than 1 indicates less. Beta is an important component of the Capital Asset Pricing Model, which attempts to use volatility and risk to estimate expected returns .

Security market line (SML)

market line (SML) is the representation of the Capital asset pricing model. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (its beta) Security. Formula The Y-intercept of the SML is equal to the risk-free interest rate. The slope of the SML is equal to the market risk premium and reflects the risk return trade off at a given time:

where: E(R i) is an expected return on security E (RM) is an expected return on ma rket portfolio M is a nondiversifiable or systematic risk RM is a market risk R f is a risk-free rate

When used in portfolio management, the SML represents the investment's opportunity cost (investing in a combination of the market portfolio and the risk-free asset). All the correctly priced securities are

plotted on the SML. The assets above the line are undervalued because for a given amount of risk (beta), they yield a higher return. The assets below the line are overvalued because for a given amount of risk, they yield a lower return There is a question about what the SML looks like when beta is negative. A rational investor will accept these assets even though they yield sub-risk-free returns, because they will provide "recession insurance" as part of a well-diversified portfolio. Therefore, the SML continues in a straight line whether beta is positive or negative. A different way of thinking about this is that the absolute value of beta represents the amount of risk associated with the asset, while the sign explains when the risk occurs.

Capital market line (CML)

Capital market line (CML) is the tangent line drawn from the point of the risk-free asset to the feasible region for risky assets. The tangency point M represents the market portfolio, so named since all rational investors (minimum variance criterion) should hold their risky assets in the same proportions as their weights in the market portfolio.

Formula:

The CML results from the combination of the market portfolio and the risk-free asset (the point L). All points along the CML have superior riskreturn profiles to any portfolio on the efficient frontier, with the exception of the Market Portfolio, the point on the efficient frontier to which the CML is the tangent. From a CML perspective, this portfolio is composed entirely of the risky asset, the market, and has no holding of the risk free asset, i.e., money is neither invested in, nor borrowed from the money market account. Addition of leverage (the point R) creates levered portfolios that are also on the CML.