The CAPM is the required rate of return and I may see it as the “fair value” for over or underpriced questions, right?
Also:
- Earn positive risk adjusted return on average= beat the market= portafolio return>benchmarks return?
Hi christopheausina,
As you stated the CAPM will give you the required rate of return so that the asset value is at it’s fair value. Therefore, if the CAPM rate is greater that the promised return by the asset, then it is overvalued (Below the SML). Otherwise, is the CAPM is lower then the asset it undervalued (Above the SML).
Earning a positive risk adjusted return (sometimes referred as Alpha), is the same as beating the market since your return is greater that the benchmark
Here’s a way of keeping things straight - The CAPM gives you the “fair” return (i.e. the required return on the asset that just compensates you for the risk involved). If you discounted the cash flows of the firm at that rate, the Intrinsic Value you’d get would be equal to the market price.
How would you receive a return that’s above the “fair” return? You’d have to buy the asset at a price below its intrinsic value. In other words, the asset would have to be UNDERVALUED. Likewise, if you overpaid for the asset (i.e. if it were overvalued), you’d receive a return that’s less than the rCAPM-required return.
Thank you to both of you, much appreciated.
That looks better.
Once again, I hereby bestow upon S2000 the title CPB (Chief Picky Bastard), with all its rights and responsibilities.
And to be clear, where I come from, the title is held in high esteem.