[Solution]Capital Asset Pricing Model (CAPM)

Student: Jason Howard Taking risks (especially when it comes to finances) is something that every organization (including the healthcare industry) must deal with daily. Most…

Student: Jason Howard
Taking risks (especially when it comes to finances) is something that every organization (including the healthcare industry) must deal with daily. Most CEOS, managers, owners, healthcare providers, etc. take these risks because of the rewards that that could be acquired as a result. To ensure that the chances of gaining income when it comes to stocks, bonds, and the value of the stocks themselves, most higher-ups utilize a tool called the capital asset pricing model (CAPM).
As Kristin L. Reiter and Paula H. Song (2021) explain; Yes, we assume investors are risk averse and demand a premium for bearing risk – the higher the risk of a security, the higher its expected return must be to induce investors to buy it or to hold it How, then, should the risk of an individual stock be measured? The Capital Asset Pricing Model (CAPM) provides one answer to the question A stock might be quite risky if it is held by itself, but—because diversification eliminates about half of its risk–the stock’s relevant risk is its contribution to a well-diversified portfolio’s risk, which is much smaller than the stock’s stand-alone risk This answer is one of many advantages as well as disadvantages when it comes to utilizing the CAPM model.
 
Advantages of utilizing the CAPM model
 
One key advantage of utilizing the CAPM model is the fact that it gives accurate prediction about relation of return and risk. (Rosha, M. 2019) When investing in any type of business involving finances, knowing the value of the company in terms of financial matters is critical for the company to thrive. Another advantage that many organizations can obtain by utilizing the CAPM model is the ability to choose which stocks to invest in by the suggestion of the model itself (Rosha, M. 2019). Other advantages include but are not limited to; Systematic risks, the CAPM eliminates unsystematic risks as well, and is great in terms of investment appraisals. (eFinanceManagement.com, 2021)
 
Disadvantages of the CAPM model
 
Despite the CAPM model having some great advantages when it comes to what kind of stocks and bonds a company needs to invest to make a profit, there are also disadvantages. One main disadvantage is the fact that it does indeed make a lot of assumptions that sometimes is not in favor of investors. Too many assumptions · Assigning values to CAPM variables · Ability to borrow at risk-free rate · Determination of project proxy beta All these indeed impact how much of a profit organization can make based upon investment strategies. Another major disadvantage about utilizing the CAPM model is the fact that it utilizes data from the past to make determinations about future investments (seekingalpha.com, 2021) If an organization made some bad investments in the past and decide to utilize the CAPM model to find better investments in the future, the chances of the tool incorporating some of that data into the new investments may occur.
 
References
Reiter L. K; Song H. P. (2021) Gapenski’s healthcare finance (7th Ed.) Health Administration Press, Chicago, IL 60606-6698
Retrieved from: https://efinancemanagement.com/investment-decisions/advantages-and-disadvantages-of-
Retrieved from: https://seekingalpha.com/instablog/48728222-dillonnimako/5105922-critique-of-capm
Rosha, M. (2019). Value of perfect information in stock picking. The Journal of Conference Series, 1317(1) http://0624j4btt.mp01.y.http.dx.doi.org.prx-keiser.lirn.net/10.1088/1742-6596/1317/1/012010

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