Market Parameters
CAPM:
E(Ri) = Rf + βi * (Rm - Rf)
where (Rm - Rf) = Market Risk Premium
E(Ri) = Rf + βi * (Rm - Rf)
where (Rm - Rf) = Market Risk Premium
Market Risk Premium: 7.50%
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Key Concepts:
- Beta measures systematic risk (market sensitivity)
- CAPM calculates required return for a given beta
- Alpha is the difference between expected and required return
- Stocks above SML are undervalued; below are overvalued
Security Market Line
Stock Analysis
| Stock | Beta (β) | Required Return | Expected Return | Alpha | Valuation |
|---|
Interpretation: A positive alpha means the stock is expected to outperform its required return (undervalued). A negative alpha means underperformance (overvalued). The SML represents the market's fair pricing of risk.