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Corporate Finance Semester Final

Corporate finance refers specifically to financing decisions made by joint stock companies. It involves planning and decision making around investment portfolios. The Capital Asset Pricing Model (CAPM) provides a framework for determining the required rate of return for any security based on its risk level as measured by beta. CAPM assumes that in an efficient market, expected return varies directly with market risk. It expresses the expected return of an asset as a function of the risk-free rate and a risk premium based on the asset's beta.

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Maruf Ahmed
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59 views3 pages

Corporate Finance Semester Final

Corporate finance refers specifically to financing decisions made by joint stock companies. It involves planning and decision making around investment portfolios. The Capital Asset Pricing Model (CAPM) provides a framework for determining the required rate of return for any security based on its risk level as measured by beta. CAPM assumes that in an efficient market, expected return varies directly with market risk. It expresses the expected return of an asset as a function of the risk-free rate and a risk premium based on the asset's beta.

Uploaded by

Maruf Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Definition of corporate finance:

Corporate finance is different form business finance. Business finance refers to the
finance of all kinds of business that is sole traders. Partnership firms, joint stock
companies. Corporate finance means only the finance of joint stock companies. So,
we can say that corporate finance is the process of decision making, planning,
project setting, according to the different portfolio of investment.
From the above discussion we have to find some question to know about corporate
finance:
1.
2.
3.
4.
5.

Should the firm launch a new product?


Which supplier have to choose for the firm?
Should the firm produce a part of the product or outsource production?
Should the firm issue a new stock or borrow money instead?
How can the manager raise money for start-up firm?

Capital Asset pricing model (CAPM)


The model explaining the risk return relationship is called capital asset pricing
model. It provides that in a well-functioning capital market, the risk premium varies
in direct proportion to risk.
According to Charles P. Johns- Capital asset pricing model relates the required
rate of return for any security with the risk for that security as measured by beta.
According to Robert,
Capital Asset pricing model is a theory which purposes to describe the structure of
security prices where all investors in the economic system are presumed to hold
efficient portfolios in expected return, variance space.
From the above discussion, it can be said that CAPM model is the model which
provides a measure of risk and method of estimating the market risk return line.

Ki= Risk free rate +Risk Premium


=

Rf + i [E ( Rm )Rf ]

Here,
Ki= the required rate of return of an asset.

E ( Rm ) = The Expected rate of return on the market portfolio.

i=

The beta co-efficient for asset.

Rf = Risk free rate.

Assumptions of CAPM:
There are some assumptions of CAPM:
1. No transaction cost, i.e. there is no cost of buying or selling any asset.
2. No taxes: there are no personal income taxes that is investors are indifferent
between capital gain and dividends.
3. Infinitely divisively assets: this means that investors could take any
positions in on investment, regardless of the size of their wealth.
4. Perfect competition: there are many investors and no single investor can
affect the price of a stock through his or her buying and selling decisions.
5. Single time period:all investors decisions are based on single time period.
6. Unlimited short sells: the individual investor can sell short any amount of
shares.
7. Unlimited lending and borrowing: all investors can borrow and lend any
amount of money at the risk free rate of return.

Formulas:
Expected return/Equilibrium return:

E( R) =

Rf + i [E (Rm )Rf ]

Here,
Ki= the required rate of return of an asset.

E ( Rm ) = The Expected rate of return on the market portfolio.


i=

The beta co-efficient for asset.

Rf = Risk free rate.

Beta with co-variance:

i=

COV rirm
2

(rm)

Here,

2(rm)=

Variance of market return.

COV rirm = covariance between stock i and market portfolio.

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