Is the return from CAPM required return or expected return? In the CFAI books, numerous places they are both…any thing I missed? Obviously in port management, it says E® = Rf + beta*RP, but in equity valuation world, it is r (required ) = Rf+beta*RP. If they ask you to compare two investments with some data, what should you use the result for, required or return? That will directly impact your choice…thanks.
Depends. If you believe in the assumptions of MPT, it is both required and expected. Usually if you look for alpha the CAPM is the required return, the deviation between that and expected return is alpha. Can be confusing though but the question should explain the approach you need to take.
Typically it is the required return…When graphed it is the SML… With that said, a forcasted return (expected return) below the SML (required return) would indicate a overvalued equity…
Thanks for clarification.
Just assume it is required. Then if you don’t have an expected return but you need it for a calc -> use CAPM and the required return as you may assume that the market is in equilibrium in which case they are equal.
If you read any text regarding CAPM, the graph always shows it is E® on y axis, but I agree with you guys in the context of MPT, it is actually required return. Expected return should be from other ways of valuation models or forecasts.