Critically analyse the relative merits of the capital asset pricing Essay - 2

Critically analyse the relative merits of the capital asset pricing model (CAPM) and verifiable approaches to asset pricing (such as the Fama and French model) - Essay ExampleThe CAPM is the graphically represented by the security market line (SML), which shows the expected rate of parry for the individual security as a function of systematic risk (indicated by the beta of the security). The SML is shown in the following figure.Suppose an investment was made in a stock with a beta of 1.5. Assuming the return on the market portfolio at 12%, and the return on the one-year treasury sequester benchmark rate to be 8%, the rate of return the investor may expect on the stock would be determined by application of the CAPM asThe stock investment is therefore expected to contribute a return of 14% to the investors portfolio, which is an improvement over the market return of 12%. The aspiration of return on the stock is important not only to balance out the portfolio, but also to enable the investor to determine the nurture of the stock. Knowing the value will enable the investor to decide whether or not he should purchase (or sell) the stock at the current market hurt. The expected rate of return is reclaimable in the discounted dividend stock valuation method. Assume the stocks regular per share cash dividend is $1 per annum without further growth, whence the stock is priced fairly atThe price of $ 7.14 is indicative of the value of the investment at the time of consideration, and it may or may not be equal to the price of the stock immediately prevailing in the market (exchange). This is then the basis for deciding what investment action to take in the asset. If the market price is presently $9 then the market overvalues the stock, and it would be a good time to sell the stock, but not a good time to buy. On the other hand, if the market price were $6, then the market underprices the stock and it would be a good time to buy, but not to sell, the stock.The CAPM is a speculative model and like all theoretical models depends on some important assumptions. The following eight