Impacts of Global Events on Financial Market

Capital Asset Pricing Model (CAPM)

The Capital Asset Pricing Model (CAPM) is one of the most widely used tools in financial analysis for determining the expected return on an investment, given its risk compared to the broader market. CAPM is predicated on the relationship between systematic risk, as measured by beta (β), and expected return. The formula is: 

Key Components:

• Risk-Free Rate: Represents the return on an investment with zero risk, typically associated with government bonds. For our analysis, we use the yield on India's 10-year government bonds as the risk-free rate.

• Beta (β): A measure of an asset's volatility relative to the overall market. A beta greater than 1 indicates higher volatility than the market, while a beta less than 1 indicates lower volatility.

• Market Return: The expected return of the market as a whole, represented by a benchmark index like the Nifty 50.

Link: Code implementation of CAPM

Interpreting the Results:

Estimated Returns:

• Reliance: 13.07% 

• Hindustan Unilever: 7.46% 

• Bajaj Finance: 16.32% 

• Axis Bank: 16.57% 

• Wipro: 8.31%

These figures represent the estimated returns investors should expect based on the risk associated with each stock. Higher expected returns generally indicate higher levels of risk.

Among the stocks analyzed, Axis Bank stands out with the highest expected return of 16.57%, this suggests a relatively higher level of risk compared to the other stocks analysed. On the other hand, Hindustan Unilever has the lowest expected return of 7.46%, indicating a relatively lower level of risk compared to the other stocks.

These findings provide insights into the potential returns of each stock during the specified time period, assisting investors in evaluating their investment strategies and allowing them to make more informed decisions.

CAPM should not be the only metric an investor relies on to invest. Instead, an investor should consider a confluence of metrics and financial analysis in order to gain better insight into their preferred assets.

Limitations of CAPM:

Assumptions: CAPM relies on a lot of assumptions such as the assumption that markets are efficient, relationships are linear and betas are constant.

Use of Historical Data: CAPM uses historical data to estimate risk and expected return however, past performance may not be indicative of future performance.

Data Quality and Availability: The accuracy and availability of the data is subjective as we have no idea how the original data was collected, cleaned, transformed or loaded.

Time-series data continuity: The data set only contains data from the last 7 years however, we have used a 10 year US Treasury Bill rate from 2013 which may not properly represent the bill rate or time-series data.