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On Investment Banking

What is the Capital Asset Pricing Model, CAPM?

18/10/2012

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by Girl Banker 

Listen to the iTunes podcast instead.

You cannot go to a corporate finance or asset management interview without knowing the CAPM.

The CAPM model shows that the return to equity is a positive function of risk: ​

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BBU (Blissful Books United) is the fictional book store created in my book To Become an Investment Banker.

  • re(BBU) is the cost of equity to BBU or said differently, it is the return that shareholders in BBU expect as a result of holding BBU shares.

  • r(f) is the risk free rate

o We can use the return on a 10-year US Government bond as a proxy for the risk-free rate, rf.
o US Government bond yields are relatively easy to get a hold of online. Some portals will even allow you to download historical data into Excel.
o The downgrading of the US Government rating from AAA to AA+ by Standard & Poor's rating agency makes the usual text book assumption that the US Government is risk free debatable.

  • β(BBU) is a measure of how volatile BBU’s share price is relative to the average of the market as proxied by a domestic stock index, e.g. the S&P500 

o If BBU is less volatile than the market, on average, β(BBU) will be less than 1.
o If BBU is more volatile than the market, on average, β(BBU) will be more than 1.

  • {r(m) – r(f)} is the difference between the expected market return and the risk free rate.

You might also like:
What is WACC, the Weight Average Cost of Capital?
Where can you get the cost debt used to calculate WACC?

Who is Girl Banker® and how can she help you?

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    Girl Banker®

    I created my investment banking blog in 2012 as soon as I resigned from i-banking & published my book, To Become An Investment Banker.

    Initially published at girlbanker.com, all posts have now been subsumed into my personal website under katsonga.com/GirlBanker.

    These blog posts make it as straight-forward for you as possible to get into a top tier investment bank. 


    I have 7 years of front office i-banking experience from Goldman Sachs and HSBC, in both classic IBD (corporate finance) and Derivatives (DCM / FICC).

    ​I'm also a CFA survivor having passed all three levels on the first attempt within 18 months - the shortest time possible. 
    ​
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Heather Katsonga-Woodward, a massive personal finance fanatic.
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