About Capital Asset Pricing Model Essay Example | Topics and Well Written Essays - 2000 words

About Capital Asset Pricing Model - Essay Example CAPM holds that investors are operating in a perfectly capital market and all securities are valued accurately. If we plot the returns on the Security Market Line than none of the returns will be above or below the SML Line. A perfect capital market assumes that information is freely available to all the investors who have homogenous expectations. Secondly, the model assumes that the assets are infinitely divisible. This assumption emphasizes that investors can take any position in investment. For instance, they can buy $1 worth of stock of Intel Corporation. The third assumption about CAPM is that personal taxes are not present which implies that returns generated in the form of dividends or capital gains are not taxed. The fourth assumption is that individual investors do not have power to affect the prices of stocks by the action of their buying and selling rather it is determined in total by their actions. The fifth assumption is that investors make decision based on expected returns or risk, the other factors such as behavioral finance is not accounted to it. The sixth assumption is that there is no restriction on amount of short sales; individuals are free to conduct as many short sales transaction as possible. The seventh and the most stringent assumption is that investors are given the choice to borrow or lend unlimit ed amount of money at the risk free rate. The eighth assumption deals with the homogeneity of the investors’ expectations which mean that all the investors have defined their relative period of investment in exactly the same manner. The final assumption withholds that all the assets are marketable whether they be financial or non-financial such as human capital. CAPM has its roots build on the model of portfolio developed by Markowitz in late 50’s. According to the Markowitz’s model of â€Å"Mean-Variance analysis†, the investors are risk averse and will prefer more return on the same level of