Assignment

Arbitrage Pricing Theory and Capital Asset Pricing Model

One of the major things to understand about this theory, the theory of arbitrage pricing, is that its concept is based on the asset pricing process. Essentially, this theory, or the APT for short, aids in establishing price models for different stock shares (Chambers, 2008). The economist Stephen Ross developed this theory in the year 1976. The main principle of this theory involves recognition that the expected return on assets may be as linear calculation of the relevant macro-economic factors and market indices. It is anticipated that there shall be some change rate in most of the relevant factors, if not all.

Running scenarios using the arbitrage pricing theory helps in arriving at a price may be equitable to the performance of the assets that is anticipated. The result that is desired is that the price of the asset will equal to the price that is anticipated for the period stated, with the end price being discounted at the implied rate, the rate implied by the model. It is comprehended that incase the price of the asset gets off course, which arbitrage will help in bringing the price back to reasonable perimeters. This theory may work well when trying to increase the long-term stock portfolio value (Chambers, 2008).

Capital asset pricing model, also known as CAPM, is a formula process that is usually used in describing the value the value relationship existing between the expected return and risk premium that is involved with the capital asset (Crouhy, 2008). This calculation of capital asset pricing model may help in establishing the relationship between the unit cost that should be realized to realize returns on the process, and the manufacturing cost of the product on sale. Understanding the pricing model is essential in evaluating the viability stock investment issued by an organization.

Through valuing stock this way, it is possible for investors to determine the degree of risk that is associated with an investment, as well as getting an idea of the type of return that they can anticipate from a venture within a certain period. This is usually referred to as market risk or systematic of investment. It is one of the main components necessary to project an outcome of adding stock to investment portfolio (Crouhy, 2008). Accurate assessment of the non-diversifiable risk, coupled with anticipated return, may be essential to the process used in arriving at usable valuation, which may help an investor make informed and quality decisions.

The best model to use in estimating the return rate on stock is capital pricing asset model. This is because it helps in establishing the relationship between the unit cost that should be realized to realize returns on the process, and the manufacturing cost of the product on sale. Through valuing stock this way, it is possible for investors to determine the degree of risk that is associated with an investment, as well as getting an idea of the type of return that they can anticipate from a venture within a certain period. Accurate assessment of the non-diversifiable risk may be essential to the process used in arriving at usable valuation. This is essential in helping investors in understanding the returns that they may get from an investment. The model also helps in estimating the risk associated with the investment. This makes it possible for an investor to hope for the best while preparing for the worst. Though this model is the most appropriate, the theory of arbitrage pricing may also be used by investor in calculating their returns on investments and any risks associated.

References

Chambers, K. D. (2008). Arbitrage Pricing Theory. Westport, Conn: Greenwood Press.

Crouhy, M., Galai, D., & Mark, R. (2008). Capital Asset Pricing Model. New York: McGraw Hill.