Concerns about Beta and CAPM (Capital Asset Pricing Model)

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The CAPM mode is very useful without any doubt. However this has certain limitations. One of the most important limitations is that most of the times the trend in the past based on which Beta is determined may not influence the returns of the future. There could be other factors happening only in the future that could alter the rate of return expectation in a given stock either by reducing or increasing the risk associated with it. As a result of this, stocks’ Betas most of the times do not have any relationship with the returns in future. There have been successful attempts to overcome this constraint in the CAPM model and it is beyond the scope of this book to discuss these attempts. However before closing this point, it will be relevant to mention that two distinguished factors influence the market return of a selected stock. They are:

The firm’s size – the smaller the size the higher the returns and

Market value to book value ratio – the lower the ratio the higher the returns

Let us conclude this topic by giving a formula for book value of equity share:

Book value of equity share = Paid up capital + Reserves and Surplus

Number of equity shares issued

 

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