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APT- Arbitrage Pricing Theory and CAPM-Capital Asset Pricing Model - Research Paper Example

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This paper "APT- Arbitrage Pricing Theory and CAPM-Capital Asset Pricing Model" focuses on these models which are applied in the assessment of any given investment’s expected returns and risks going in tandem. In both, formulas are used in the determination of the required rate of return.  …
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APT- Arbitrage Pricing Theory and CAPM-Capital Asset Pricing Model
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Download file to see previous pages Therefore, if beta equals 1 this stock is equally risky with the market if it is 2 the same stock is twice risky in comparison to the market. While on the other hand, APT utilizes individual factors in place of beta. Also APT does not apply the market return rate and thus considered to be more particular to a given stock in focus. CAPM’s data is objective while APT applies data from a single stock. Thus, CAPM is recommendable to an investor who is relatively dormant as compared to APT, which if correctly applied is better placed to assess projects. (Grover, 2010)
Some authors have applied APT and compared the resultant estimates with those of CAPM. Patterson notes one of the cases where such has been done is the electric utility’s, written by Ross and Roll in their 1983 book. According to Patterson the end results of APT were credible in comparison to those of CAPM. But, this was without enough justification for the results. (Patterson, 1995 p151)
Besides the first two, there are methods of assessment like the Dividend Growth Model and Modern Portfolio Theory. The Dividend Growth Model shows the value of ordinary shares in a present value of the prospected future flows of cash which has been invested by an investor. The receivable cash inflows are taken as dividends as well as the expected price in future while the stock will be disposed of. An ordinary share usually does not possess the maturity and thus, it is held for numerous years. Therefore, a general ordinary shares’ valuation introduced by Gordon would be as below;
Just to mention, the other model investment assessment is known as MPT- Modern Portfolio Theory. This is a theory applied by investors who are risk averse and at the same time, they want to achieve maximum or optimum level of expected return which is based on the market risk level. It emphasizes that risk is inherent in the process of getting the rewards associated with it.   ...Download file to see next pagesRead More
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