CAPM Capital Asset Pricing Model in 4 Easy Steps – What is Capital Asset Pricing Model Explained

CAPM Capital Asset Pricing Model in 4 Easy
Steps – What is Capital Asset Pricing Model Explained Hello I’m back and welcome once again to
another easy lesson or review or tutorial by So, today or this time our topic will be on
or about CAPM or the Capital Asset Pricing Model in the field of finance or Financial
Management. Management sounds scary or complicated but
don’t worry this is just MBAbullshit. And we can cut through the bullshit and you
can see how easy and simple it actually is. Okay, just remember you can always come here
whether you’re a business student, college BBA or MBA or if you’re an executive who
just wants to learn because you don’t have time for MBA or because you need refresher
from your previous MBA or if you’re a non business moron like me before and maybe an
artist, or a creative person or a doctor and you just want to learn the concepts of MBA
quickly and easily. You can always go to for lots
of free video. Okay? So now, let’s go to the Capital Asset Pricing
Model. Now, most professors will explain the Capital
Asset Pricing Model or CAPM as a formula which looks like this: Ke = Rf + B (Rm-Rf). Now, I know this formula over here can look
scary and intimidating but please do not panic because this is actually very simple when
I show you step by step how easy it actually is. So, don’t worry about it but in order to
allow you to understand it well, I want you to first remove this first complicated bull
shit from your brain right now temporarily. We’ll get back to it later. Remove it from your brain, don’t panic and
I just want you to focus on this other thing I’m going to show you now. Okay? You’re going to see, it’s not complicated
at all. So, I’m going to start by telling you a
story and in the story I’m going to give you a choice. Let’s say, I offered you a risk free investment. Okay? It was an investment or it’s an opportunity
for you to earn money by putting your money in my bank. You have a deposit account in my bank and
my bank is guaranteed by the government and so therefore it is risk free, zero risk and
for sure the bank will not collapse like what happened in the recent economic crisis. In this case you’re 100% sure that the bank
would not collapse. And you have the opportunity, you have the
offer to deposit your money in this bank and the bank will give you an interest of 2%. So the 2% here is what we called the risk
free rate. So let’s just say that you can put your
money in my bank, my bank has no risk and you can earn 2% interest or 2% income or 2%
profit on your money by depositing that money with this bank. And then I give you a second choice with an
investment which has medium risk. And for this example, let’s just use or
let’s just say that the United States stock market, the general stock market has medium
risk. So bank here, the bank deposit has no risk
or zero risk and the US general stock market has medium risk which is also called systematic
risk. Now, don’t worry so much about the systematic
risk here. This is just MBAbullshit and for now let’s
just use the word medium risk and we can get back to the systematic risk later. It’s called systematic risk because it represents
the risk of a certain system which is usually used such as the United States stock market. But if you don’t understand what I just
said don’t worry about it, just forget it for now. For now let’s just say it’s medium risk. Now, what if I also offered you a risk free
investment, zero risk investment or deposit earning 2% and I also offered you a medium
risk investment? And this medium risk investment would earn
you also 2%. It would also earn you 2%. So if you had to choose between this investment
here or this investment here, which one would you choose? Which one? They earn the same amount but this one has
higher risk than this. Well if you have at least some intelligence
then for sure you would choose this investment and not this one. Why? Because in this investment you earn 2% but
you have no risk. In this investment you also earn the same
small profit of 2% or you expect to earn the same small profit of 2% but you have even
higher risk compare to this one over here. So of course it makes much better sense to
put your money here in the no risk investment. Let me ask you; let’s say I was a stock
broker who trades stocks in the United States and I want to convince you to move your money
away from here and instead put your money here. How would I do that if I’m only giving give
you 2%? Well, of course the normal way would be for
me to try an offer you more than 2% and I’d tried to offer you extra money, extra profit
or extra percentage here. That way it would be worth it for you to move
your money from here to here because now you’re earning more profit in order to pay you for
the extra risk. For this example, let’s just say I’d offer
you an extra 6% return or extra 6% profit on your money to place your money here instead
of here. So now, these two investments have equal attractiveness,
let’s just called it equal attractiveness because here you only earn 2% but you’ve
got no risk, here you earn 2% plus 6% but you have medium risk and medium risk is more
than no risk. So now, these 2 choices should have equal
attractiveness. debbierojonan Page 1

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