Respond to each classmate 100 words or more

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Discuss the Capital Asset Pricing Model. What is its importance in finance?

Classmate 1

Besley (2015) defines Capital Asset Pricing Model (CAPM) is a model used to regulate the required return on an asset, based on the proposition that any asset’s return should be equal to the risk-free return plus a risk premium that reflects the asset’s non-diversifiable. CAPM illustrates the risk of an investment as measured by its beta coefficient to determine its required rate of return. The expected rate is based on the probity distribution for the stock’s return and the rate that investors expect to earn if they purchase the stock. The required rate of return is the rate investors demand investing in stock based on its relevant risk. The return on U.S. Treasury securities typically measures a risk-free rate of return. The beta coefficient is the beta of an average stock. The required rate of return on a portfolio includes all stocks and requires a rate of return on an average stock. The market risk premium is the additional return above the risk-free rate needed to compensate an average investor for assuming an average amount of risk. The risk premium on the stocks risk premium is less than, equal to, or greater than the premium on an average stock, depending on its relevant risk is measured by beta is less than, equal to, or greater than an average stock, respectively. However, there should be caution used when using CAPM. Investors and analysts use CAPM and the concept of B to provide “ballpark” figures for additional analysis. CAPM provides a way to get a “rough” investment of the relevant risk and the appropriate required rate of return of an investment (Besley & Brigham, 2015, pp. 418-424).

Classmate 2

The Capital Asset Pricing Model (CAPM) determines the required rate of return of an investment. It shows the risk of an investment to find the rate of return. Ra=Rrf+βa∗(Rm−Rrf) is the CAPM formula. Ra is the expected return. Rrf is the risk-free rate. Rm is the expected return of the market. βa is the beta of the security. (Rm−Rrf) is the equity market premium. The CAPM portrays how the financial market price securities and then find the expected returns on investments. It is the nature of the estimated costed cost of equity that the CAPM model yields. A financial manager may use the CAPM model for other techniques. They can also use their judgment to develop useful and realistic calculations.