Question
Download Solution PDFWhich one of the following analyses is suitable for risk-return analysis in financial decisions?
Answer (Detailed Solution Below)
Detailed Solution
Download Solution PDFCAPM Analysis is suitable for risk-return analysis in financial decisions.
Explanation:
Capital Asset Pricing Model (CAPM)
- The Capital Asset Pricing Model (CAPM) describes the relationship between systematic risk and expected return for assets, particularly stocks.
- CAPM is widely used throughout finance for pricing risky securities and generating expected returns for assets given the risk of those assets and the cost of capital.
CAPM is calculated according to the following formula: Ra = Rrf + [Ba x ( Rm - Rrf )]
Where:
- Ra = Expected return on a security
- Rrf = Risk-free rate
- Ba = Beta of the security
- Rm = Expected return of the market
Note: “Risk Premium” = (Rm – Rrf)
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