CAPM Review

The CAPM model is based on specific assumptions. The investor could borrow or lend any amount of money at risk less rate of interest.

All investors hold only market Portfolio and the restless securities. Market portfolio consists of the investments in all securities of the market the proportion invested in IT security is equal to the percentage of the total market capitalisation represented by the security. 

The capital market line represents the relationship between the expected return and standard deviation of the portfolio. The risk of the security is indicated by its covariance with the market portfolio.

Security market line shows the linear relationship between the expected returns and betas of the securities. The objective of the asset pricing model is to identify the equilibrium asset price for expected return and risk. If if the asset prices are not equal, there is a scope for arbitrage.

An arbitrage portfolio is constructed without any additional financial commitment. Investors indulge in arbitrage, moving the price opposite securities are held long and driving down the price of securities if held in short position, till the elimination of the arbitrage possibilities. The factor sensitivity in arbitration model in the case the responsiveness of a securities return to a particular factor.