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Essay / Research Paper Abstract
This 6 page paper compares and contrasts the Capital Asset Pricing Model with Arbitrage Pricing Theory, looking at the differences and similarities and assessing which of the models is most reliable for predicting asset prices. The bibliography cites 6 sources.
Page Count:
6 pages (~225 words per page)
File: TS14_TEcapmapt.rtf
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Unformatted sample text from the term paper:
there are proponents of different models, two which have emerged as potential contenders for the title of the most accurate, effective or reliable model in terms of their predictive capability
are CAPM and APT. To consider which of these is the strongest both need to be considered. CAPM was developed as
an extension of the modern portfolio theory which was introduced in 1964 by William Shape. It expands of the concept of modern portfolio theory is as the model allows for
specific and systematic risks. This is a theory which facilitates the computation of risk and the compensations that are due to that risk. Systematic risk applicable to any single asset
can be reduced through diversification as this allows for a spread of risk to reduce the overall risk, this is known as systematic risk. The risk of any investment
is usually measured in terms of the beta (which actually measures volatility which equates to risk for investors), the greater the beta the higher the potential risk and also the
potential reward. In CAPM compensation is gained from taking this systematic risk. However, if a singe company is invested in then
there will be a specific risk; it is this specific risk for which the market will not provide compensation. The reason for this is that this specific risk can be
diversified away. The model does make some assumptions; there is an assumption that there are no transaction costs in trading such as taxes, stamp duties or sales costs; that all
investors have the same investment preferences/profiles, expecting the same returns and performance on risky investments and that all investors maintain the same investment horizons.
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