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CAPM
 

How to use CAPM in a sluggish market?

Kemm's picture
IB
 
Points)
 on 11/27/12 at 5:16am

a quick question - how to value a company using CAPM to caculate cost of equity of a bad market. Take China's Shanghai stock market as an example, the index decreased from 6,000 in 2007, to 3,000 in 2010, to 1,990 in 2012. we could not use a negative risk premium, right?

thanks!

Testing CAPM

jessylox's picture
(Chimp, 11
 
Points)
 on 11/17/12 at 11:51am

Hi guys,
I'm testing CAPM and Fama&French factors models but I got so much diverisfied portfolio that I don't know which proxy I should get. My portfolio (48 assets):
20 - equity indices for industry and countries
10 - fixed income
5 - futures on commodities
3 - actively managed mutual funds
6 - privately-owned equities
4 - alternative investments
I can't change the portfolio. What would you choose for market proxy?

Finance Hipsters

mikesswimn's picture
O
 
Points)
 on 11/18/12 at 8:00am
hipster banker.PNG

Morning Monkeys!

I'd like to take a moment to discuss the growing multitude of "finance hipsters" and why they annoy the crap out of me. No, I'm not talking about hipsters who happen to work in finance, I'm talking about all these bankers who love to hate on the more ubiquitous methodologies in finance like CAPM (or portfolio theory in general) and DCF models. You all know what I'm talking about, in fact, at some point, you (or someone you know) has probably had this conversation:

Banker #1:

I'm going to get the cost of equity using CAPM and then get the intrinsic value from my DCF model.

Banker #2:

Oh, you still use CAPM and DCF? Man, that's so déclassé, you know the assumptions they use, right? You should use [insert any obscure, probably firm specific model], it's way better.

Replace "the cost of equity using CAPM" and "the intrinsic value from my DCF model" with "Modest Mouse's new CD" or "non-organic milk" and you have the quintessential hipster conversation.

Hamada formula

cruel3a's picture
CF
(Orangutan, 287
 
Points)
 on 10/28/12 at 1:41pm

Hi guys,

When we use the Hamada formula to re-lever an unlevered beta, what do we use as equity value since it is the target of our valuation?
Should we use the average capital structure of our comparables sample? If we do it this way, wouldn't we end up with the same levered beta we had at the beginning?

What is a reasonable market return estimate for Pfizer Inc.?

SevenFootPelicans's picture
(Chimp, 13
 
Points)
 on 5/2/12 at 8:28pm

What would a reasonable market return (estimate) be for Pfizer Inc. be or any other comparable company? By comparable I mean a large cap, low beta, economically stable pharmaceutical firm (such as Merck & Co. etc.

But more importantly, how did you arrive at this figure? I'm doing a project in where I have to come up with a required rate of return for a certain company I'm investing in, but, I'm having a tough time figuring out where to begin when determining a reasonable market return (which is included in my equity risk premium) for my company (Pfizer).

Again, this is merely for a project, and I need advice on where to start when determining an appropriate figure for market return.

Help?

CAPM question

simpleguy's picture
 
Points)
 on 1/2/12 at 1:43am

What do you use for the risk free rate when calculating the cost of equity using CAPM?

I have heard some different opinions, some places/guides say the 10 year US Gov Bond others say 3 month, etc.

I would imagine that the answer is that it depends, but what does it depend on?

Thanks.

What Is The Capital Asset Pricing Model (CAPM)?

The Capital Asset Pricing Model, or CAPM, is one of the most commonly used models for calculating the expected return on an asset and is used to price securities.

The CAPM requires 3 data inputs:

  • Beta of the asset (how much it moves relative to the market)
  • Risk free rate (i.e. government bond yield)
  • Expected return of the market (i.e. S&P return)

With all these figures, the calculation for the expected return is:

  • Expected Return on Asset = Risk Free Rate + (Beta Asset x [Expected Market Return – Risk Free Rate])

For example, assume the following:

  • Risk Free Rate = 2.5%
  • Beta = 1.8
  • Expected Market Return = 5%

CAPM, WACC, Corp Finance Videos

Hamchuck's picture
IB
(Monkey, 33
 
Points)
 on 8/31/11 at 11:21am

I want to brush up on corporate finance and was wondering if there are any good video programs out there on the topic. Mainly concerned about getting the nitty gritty down about CAPM.

Which Internship to choose from ( PWM) ?

pdxskiier's picture
(Chimp, 5
 
Points)
 on 8/16/11 at 6:27pm

Hey guys,

I have been lurking on here for a while, and this is my first post.

I have two internship offers this fall ( couldn't find anything spectacular). There both at BB in PWM. I really can't decide which one would be more beneficial or rewarding, and was hoping to get some input.

The first internship would be me working under management. The financial advisers essentially would be our clients. I was told I would be putting on events, and would help scheduling conferences. I am not 100% sure what this would entail.

The second internship would be working with a team of financial advisers, helping with powerpoints, some excel work, and word. No cold calling. The prospects would essentially be our clients.

Question on alpha and beta

levered_cashflow's picture
(Chimp, 2
 
Points)
 on 3/28/11 at 3:00am

Hi,
Recent college graduate and new here to WSO, very excited to learn more about Finance. I have recently started creating an investing sort of tool in excel and I have a question regarding alpha and beta.

As I understand (correct me if I'm wrong), it is a widely debated topic, whether it is better practice, to maximize alpha or to minimize beta. Alpha equals the return of a stock over what it's risk warrants (as depicted by CAPM for example).

Putting this together I realized, by choosing to minimize beta, you are inadvertently maximizing alpha, since alpha is a function of beta (indirectly). Am I right in this theory and if so, should we direct our attention primarily towards stocks' betas?

Thanks!

Beta in CAPM

doctortt's picture
O
 
Points)
 on 1/12/11 at 8:27am

Hi there,

I'm a little confused. I searched the net, and different sites said different things. In the CAPM formula to calculate the cost of equity, is the Beta levered or unlevered? Can someone clarify for me please?

Thanks

Expected Market Returns

JustNumbers's picture
IB
(Baboon, 108
 
Points)
 on 3/27/10 at 11:40pm

I can't figure out how the expected market return is calculated. I understand it's function in CAPM and in determining beta. But I don't see how any value for expected market return, market covariance with your stock, or variance of the market, that you're given is reliable.

Has someone ever calculated the expected return for each asset available, the SD for each asset, or correlation between every pair of assets?

To me this seems like the #1 flaw of CAPM because subjective probabilities are needed to even generate variance!!!

Sorry I've been studying for CFA recently.

negative beta and Re

wallstreet2010's picture
IB
(Chimp, 9
 
Points)
 on 10/7/09 at 5:50pm

Had a superday at a bulge bracket…

In my first interview of the day, I was asked whether debt or equity is a more expensive form of capital. I answered equity because it’s less senior in the capital structure and thus more risky and because of the interest tax shield.

He followed up by asking if there were any situations in which equity would be less expensive than debt… I struggled for a bit and said I couldn’t think of any because debt is always senior to equity. He took me back to CAPM and told me that if a firm had a negative beta, that could make its cost of equity lower than its cost of debt.

Most important part of a valuation???

big_dreams_banker's picture
IB
(Baboon, 158
 
Points)
 on 8/27/09 at 2:29am
Confused Monkey

Ok everybody...I would love to get as much input on this from as many people from as many countries as possible.

I just spoke with a senior banker (remember I am in India), and he told me that in the entire valuation process significantly more importance is given to the creation of the Financial Statements etc. than to the actual valuation (i.e. finding beta, the cost of equity, CAPM, WACC and all that good stuff we learned about in school).

He says that there are certain standard assumptions which are used across the industry for things like beta, cost of equity etc. and that there is no point in making the model complex by digging into these things too much 'coz in the end they will only make a marginal difference.

An easy CAPM question

jimmy889's picture
IB
(Chimp, 2
 
Points)
 on 8/18/09 at 12:01am

Hey guys,

This is probably obvious but I'm not seeing the answer. In CAPM and I guess you could generalize this to anytime you are using a tax shield, why do you just take the whole value of debt and multiply it by (1-t). I thought principal payments were not tax deductible, so in the CAPM formula they should just be multiplied by just the cost of debt and not (1-t). Is this just a classroom generalization and in banking models they account for this distinction, or is there something I am missing?

Thanks.

CAPM and Cost of Capital

Jupiter26's picture
IB
(Chimp, 6
 
Points)
 on 3/17/09 at 3:16pm

Hey,
So I’ve started to study up on DCF valuation. I get the basics, however, why is CAPM used to estimate the cost of capital? I thought that empirical studies show that CAPM is a poor way of estimating returns. So the difference between companies is beta, which is the relative systematic risk compared to the market. Where does CAPM take into account liquidity, leverage, threat of substitutes etc? I guess my question is, is there a different way to estimate the cost of capital?

CAPM

lotus6's picture
O
 
Points)
 on 11/6/08 at 10:52am

Is CAPM used often?