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

Critically break the relative merits of the capital asset pricing model (CAPM) and empirical approaches to asset pricing (such as the Fama and french model) - Essay ExampleThe CAPM is the graphically represented by the security grocery store line (SML), which shows the pass judgment charge per unit of remember for the individual security as a function of systematic risk (indicated by the of import of the security). The SML is shown in the avocation figure.Suppose an enthronisation was made in a burgeon forth with a genus Beta of 1.5. Assuming the return on the market portfolio at 12%, and the return on the one-year treasury bond 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 contri hardlye a return of 14% to the investors portfolio, which is an improvement over the market return of 12%. The determination of return on the stock is important not on ly to balance out the portfolio, but also to enable the investor to determine the value 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 price. The expected rate of return is useful in the discounted dividend stock valuation method. Assume the stocks regular per share interchange dividend is $1 per annum without further growth, then 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 presently prevailing in the market (exchange). This is then the basis for deciding what investment action to watch in the asset. If the market price is presently $9 then the market overvalues the stock, and it would be a grave 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 g ood time to buy, but not to sell, the stock.The CAPM is a theoretical model and like all theoretical models depends on some important assumptions. The following eight