CAPITAL MARKET THEORY
In portfolio selection, not only returns but risk are also to be
considered as in case of single investment. In aggregation of risk two
and two does not always make it four as suggested by Markowitz in
his Portfolio Model. This model was mechanically so complex that it
could not be practically adopted either by practitioners or by
academicians. The risk in portfolio of asset will not be the total of risk
of individual investment, it can be more or less than the total. The
objective of every investors however is to minimize the risk for given
return. This article deals with Capital Market Theory.
CAPITAL MARKET THEORY
Capital market theory is an extensions of the portfolio theory of
Markowitz. Markowitz used mathematical programming and
statistical analysis in order to arrange for the optimum allocation of
assets within portfolio.
The Concept of Capital Market Theory is that it tries to describe and
evaluate the advancement of capital and likewise financial market
over a certain period of time. The Capital Market Theory in general
tries to clearly define and foresee the development and advancement
of capital. It is also known to be a common term that is used for the
study of securities. In terms of the relationship between rate of
returns seemed by all investors and likewise the inheritance of risk
that comes along.
Capital Market Theory tries to explain and predict the progression of
capital (and sometimes financial) markets over time on the basis of
the one or the other mathematical model. Capital market theory is a
generic term for the analysis of securities.
In terms of trade-off between the returns sought by investors and
the inherent risks involved, the capital market theory is a model that
seeks to price assets, most commonly, shares.
, In general, whenever someone tries to formulate a financial,
investment, or retirement plan, he or she (consciously or
unconsciously) employs a theory such as arbitrage pricing theory,
capital asset pricing model, coherent market hypothesis, efficient
market hypothesis, fractal market hypothesis, or modern portfolio
theory.
ASSUMPTIONS OF CAPITAL THEORY
Their crucial and important assumptions of the above mentioned theory
are as follows;
All investors are resourceful investors- Investors follow Markowitz
idea of the efficient frontier and thus prefer to invest in ranges of
and along the boundary.
• Investors borrow/lend money at risk-free rates- These risk-free
rates are fixed at any point of time
• No inflation exists- These returns seemed by investors are not at all
affected by the inflation rate in the country within the capital market
as it is fictional and does not exist in the capital market theory
concept.
• All investors have the same probability for outcome- Predicting the
expected rate of return each investor have identical probability for
an outcome.
• All assets are marketable. All assets including human capital be
sold and bought in the market.
There is perfect completion in the market. No individual investors
can affect the price of the stock by his buying or selling action and
investors in total determine prices by their actions.
There is no transaction cost i.e. cost of buying or selling any asset. To
include transaction costs in the mechanism adds a great deal of
complexities. Whether it is worthwhile introducing this deals of
complexities. Whether it is worthwhile introduction this complexity
depends on importance of transaction costs to investor’s decision.
CAPITAL ASSET PRICING MODEL
In portfolio selection, not only returns but risk are also to be
considered as in case of single investment. In aggregation of risk two
and two does not always make it four as suggested by Markowitz in
his Portfolio Model. This model was mechanically so complex that it
could not be practically adopted either by practitioners or by
academicians. The risk in portfolio of asset will not be the total of risk
of individual investment, it can be more or less than the total. The
objective of every investors however is to minimize the risk for given
return. This article deals with Capital Market Theory.
CAPITAL MARKET THEORY
Capital market theory is an extensions of the portfolio theory of
Markowitz. Markowitz used mathematical programming and
statistical analysis in order to arrange for the optimum allocation of
assets within portfolio.
The Concept of Capital Market Theory is that it tries to describe and
evaluate the advancement of capital and likewise financial market
over a certain period of time. The Capital Market Theory in general
tries to clearly define and foresee the development and advancement
of capital. It is also known to be a common term that is used for the
study of securities. In terms of the relationship between rate of
returns seemed by all investors and likewise the inheritance of risk
that comes along.
Capital Market Theory tries to explain and predict the progression of
capital (and sometimes financial) markets over time on the basis of
the one or the other mathematical model. Capital market theory is a
generic term for the analysis of securities.
In terms of trade-off between the returns sought by investors and
the inherent risks involved, the capital market theory is a model that
seeks to price assets, most commonly, shares.
, In general, whenever someone tries to formulate a financial,
investment, or retirement plan, he or she (consciously or
unconsciously) employs a theory such as arbitrage pricing theory,
capital asset pricing model, coherent market hypothesis, efficient
market hypothesis, fractal market hypothesis, or modern portfolio
theory.
ASSUMPTIONS OF CAPITAL THEORY
Their crucial and important assumptions of the above mentioned theory
are as follows;
All investors are resourceful investors- Investors follow Markowitz
idea of the efficient frontier and thus prefer to invest in ranges of
and along the boundary.
• Investors borrow/lend money at risk-free rates- These risk-free
rates are fixed at any point of time
• No inflation exists- These returns seemed by investors are not at all
affected by the inflation rate in the country within the capital market
as it is fictional and does not exist in the capital market theory
concept.
• All investors have the same probability for outcome- Predicting the
expected rate of return each investor have identical probability for
an outcome.
• All assets are marketable. All assets including human capital be
sold and bought in the market.
There is perfect completion in the market. No individual investors
can affect the price of the stock by his buying or selling action and
investors in total determine prices by their actions.
There is no transaction cost i.e. cost of buying or selling any asset. To
include transaction costs in the mechanism adds a great deal of
complexities. Whether it is worthwhile introducing this deals of
complexities. Whether it is worthwhile introduction this complexity
depends on importance of transaction costs to investor’s decision.
CAPITAL ASSET PRICING MODEL
