Please respond to the following discussion topic. Your initial post should be a minimum of 300 words in length. Then, make at least two thoughtful responses to your fellow students’ posts.
To CAPM or not to CAPM – that is the question. CAPM is a valuable tool that often comes under fire for all the estimates it relies upon. What are the key estimates used in CAPM? Why is this measure so harshly criticized? Do you agree with the critics? Why or why not?
After reading into what CAPM does, and how it benefits a company. It reminds me of how the military uses a similar model to forecast and budget for various operations. I know there is a difference between war and financing a company. I believe it’s all related in different areas. In peacetime, funds are allocated for training, equipment, and education to update Soldiers for advanced technology. For example: GCSS ARMY (Global Combat Support System-Army), is at the fore front of technology and automated systems. It’s used for tactical logistics operations. The same operations are used in civilian federal applications as well.
What I’m saying. There are upper echelon investors and people of interest that are expecting high return on investments from this program. The return on investment is guided through a budget that has a high expected outcome. Anyone that have served in the military knows that budgets are based on the validity of a mission. Not all missions are the same; however, strategic levels plan based on current changes. Sometimes more or less funds are spent just to see how well training was executed. This is a huge topic when referencing the military because nothing never remains the same; therefore, CAPM is needed to manage spending. I do believe CAPM is needed and should be used to keep investors in the know on where the money is going, and how well it is being diverted into specific area of interest.
The model of CAPM or as it is formally known as, capital asset pricing model is one that has been stated to have both many pros and cons. This model is an established theory that shows the linear relationship between the required return and the associated risk. As defined the model is based on the relationship between an asset’s beta, the risk free rate, and the equity risk premium (Zucchi, 2019). When an investor is looking to make large or small investments for their own portfolios, it is assumed that if an investor makes a risky investment, then it is assumed that the reward will be high. The CAPM allows this risk analysis to be solved. The CAPM method is known to be diversified. The criticism that comes with this method is that the CAPM method may over inflate returns in unrealistic returns. There are four main positives and four main drawbacks to this method. The positives to this method include the ease of use, the diversification of the portfolio, which limits the risk, the variabilities in risk, and lastly the use of market risk. The four drawbacks that are discussed are the risk free rate and the ability to borrow at a risk free rate along with return on the market and the determination of the beta.
Due to the fact that the variables include investors with the ability to borrow risk-free is simply unrealistic. While government or treasury bonds are typically seen as low risk, there are still values of risk. For this reason and for the reason that I tend to err on the side of caution, I agree with the critics that state the CAPM method is too risky as it is possibly inflating the returns for investors.
Kristina Zucchi, C. F. A. (2019, April 14). CAPM Model: Advantages and Disadvantages. Retrieved from https://www.investopedia.com/articles/investing/021015/advantages-and-disadvantages-capm-model.asp.
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