The Capital Asset Pricing Model (capm)Essay Preview: The Capital Asset Pricing Model (capm)Report this essayIntroductionThe Capital Asset Pricing Model (CAPM) has broadly used by investors and corporate finance, the reason behind this is because due to the elegance of the model for investor easy to use and obtained expect return while exposing to the systematic risk. The most critical factor within CAPM model is the systematic risk of the single stock; typical systematic risk includes interest rate, inflation, economic cycle, policy uncertainty and widespread natural disasters.
Nowadays, most of the Chinese company choose U.S to go public trade. China has picked up market economic from planned economic since 1978. Almost 40 years later, China has now become a secondary largest economic system in the world. The relatively fast economic growth creates more opportunities and attracts more investors. IPO in U.S. stock exchange has number benefit to Chinese based company.
1.Lower finance cost and shorter time compare IPO in China A & B market. In U.S., approximate 12% of the capital fund invested into Non-U.S. Company.2.Enhanced its reputation and value by increase media attention.3.Import foreign technology and management system to improve the domestic company.4.U.S. stock exchanges provide more liquidity, acceptance and branding to the investor. The US has the largest overall pool of equity capital compare to the everywhere else in the world with a wider margin. Liquidity is critical for an investor as is indicate the sufficiency of supply and demand in the trade market.
China is the largest emerging market in the world; there is some inherent risk associated with the Chinese based company that the U.S. investor could pay attention, such as the government policy, stable relationship between China and U.S. and so forth. Some of these risks would affect the stock performance of Chinese company, while other risks may create ongoing concern of the company, which would also create disaster toward the investor who holds a position of the stock.
This research is aim to address following two question regarding the risk factor in the CAPM.1.How would systematic risk of policy uncertainty impact to U.S. investor who holds a position of Chinese based company stock?2.How does trade war affect investors?The purpose of this research is to introduce and identify the systematic risk of policy uncertainty, which would influence the result of the CAPM model. This research will focus on impaction of following issues.
1.Policy uncertainty risk, what is the possibility of a trade war between China and U.S.2.What is the impaction of trade war toward the stock performance of Chinese based company that listed on U.S. stock exchanges?Literature ReviewThere is a trade-off between risk and return, as the development of portfolio investment management proceed, the non-systematic risk of an asset can be diverse. Therefore only systematic risk remain to be compensated as a return for investors to absorb the risk (Vijay.S 2016). This literature review will first review the fundamental relationship between systematic risk and return in the CAPM, then a different opinion of a trade war between U.S. and China will evaluate to exam the possibility of the trade war.
1
2. Economic policy and the Chinese economy.3. China’s role in world globalism as a global player, as China seeks to take over the global governance role.4. The importance of cooperation as China seeks global leadership and leadership on economic and social policy at the global stage.5. China’s military build-up and its influence in the current military landscape and the ability to expand its support to the region and globally.6. the extent to which China’s role in global macroeconomic policy as a global player has been enhanced by growing Chinese real GDP and expanding the strength of its export-oriented business.7. China is not a member of any specific international group, i.e. one that has the capacity to achieve significant financial and economic cooperation.8. China cannot expect, or agree with, the security guarantees of the United States and that of the member states (Sobler. S. 2015a).9. China is not an independent economic state, neither has its relationship with the international community.10. China’s policy towards the U.S. would be a global policy for the protection of interests in the U.S. (Stroeve. T. 2001). The US is China’s largest economic customer and that is China’s role in securing its membership and participation in the global financial system as a global arbiter (Hoffman. S. 2007).11. China is not an economic state, neither is it an independent economy.12. China is not a member of any particular grouping and may not have the ability to join with the majority of others in a specific global or security context: economic interlocutors or non-trade partner (Xiang. B. 2010).13. China will not join in any economic or security context where it is actively engaged in an international security conflict and China is not an economic state.14. China will not be considered to be a relevant supplier, nor will it participate in any international security situation.15. China plays no role in the U.S. regional security environment.16. China cannot play any roles in the international security environment where it is developing.17. China has no relationship with the United States, nor with any of the other members of the G20 and is an economic State.18. China is not as dependent as other member states on the U.S.-China exchange rate, nor as it is developing its own trade.19. China is not as dependent on the United States for economic security as other member states (i.e. a member of an international non-military organization).20. China has no access to any external investment and thus does not have the means to access the global market.21. China is not a major participant in any ongoing security agreement (e.g. U.S. military and military-related or bilateral security agreements).22. China does not currently have a financial incentive to
Risks to the Value of a Stock
1.A. The risks associated with risks to stocks as they relate to U.S. companies
The risk of being listed on U.S. or Chinese stock exchanges is a strong indicator of the potential for a significant trading deficit (Iyer.JW.S. 2017; Wiedemann.R.S. 2016). Stock volatility is often measured with a range of weights. There are few such scales (Zhang, Wu and Liao.R.S. 2013:11–18). Such a variation of weights would explain that, in the last few years of China’s history, stock price volatility has fallen on the Chinese Stock Exchange (Iyer.JW.S. 2016).
U.S. companies are a key player by being listed on the Chinese Stock Exchange, but are also dependent on the price volatility of their underlying Chinese company(s). There is also concern regarding a trade war between U.S and Chinese, as it is considered possible that these trading parties will be able to influence U.S. trading decisions to their advantage or against the wishes of U.S. and Chinese investors. U.S. companies have thus faced the option of being listed on exchanges across China. Thus, it would be prudent to assess risk of trading loss with the value of the stock itself.2. A trade war with the stock of any U.S. company would be highly speculative in the shortrun. Given the high cost and expense of any U.S. investment, the need to monitor the long term of a stock is likely to come in the form of an exchange report issued by the securities regulator in the U.S. This could lead to trade conflict. In order to assess the risks such a trade war would produce, it is likely that U.S. stock trades would have to be more volatile than before. This trade war will be a very stressful experience for U.S. shareholders.
2.1. Expected volatility of Chinese Stock
If the stock was listed with a negative yield, prices would spike rapidly in exchange volumes. This would lead to greater volatility of the stock. As such, a market cap trade can come to significant risks, especially for U.S. investors. The high volatility of Chinese stocks is likely to bring about the risk of volatility of U.S. stocks. The probability of a trade war between the U.S. and China is a potential indicator of the possibility of a trade war between the U.S. and Chinese.
2.2. Potential of a Trade War Between the Company and the Stock
For every 100 shares of U.S. stock traded on the Chinese Stock Exchange, 100 of the shares traded on the U.S. stock exchanges would have increased their price to be more than the value and would be considered a trade sale
Risks to the Value of a Stock
1.A. The risks associated with risks to stocks as they relate to U.S. companies
The risk of being listed on U.S. or Chinese stock exchanges is a strong indicator of the potential for a significant trading deficit (Iyer.JW.S. 2017; Wiedemann.R.S. 2016). Stock volatility is often measured with a range of weights. There are few such scales (Zhang, Wu and Liao.R.S. 2013:11–18). Such a variation of weights would explain that, in the last few years of China’s history, stock price volatility has fallen on the Chinese Stock Exchange (Iyer.JW.S. 2016).
U.S. companies are a key player by being listed on the Chinese Stock Exchange, but are also dependent on the price volatility of their underlying Chinese company(s). There is also concern regarding a trade war between U.S and Chinese, as it is considered possible that these trading parties will be able to influence U.S. trading decisions to their advantage or against the wishes of U.S. and Chinese investors. U.S. companies have thus faced the option of being listed on exchanges across China. Thus, it would be prudent to assess risk of trading loss with the value of the stock itself.2. A trade war with the stock of any U.S. company would be highly speculative in the shortrun. Given the high cost and expense of any U.S. investment, the need to monitor the long term of a stock is likely to come in the form of an exchange report issued by the securities regulator in the U.S. This could lead to trade conflict. In order to assess the risks such a trade war would produce, it is likely that U.S. stock trades would have to be more volatile than before. This trade war will be a very stressful experience for U.S. shareholders.
2.1. Expected volatility of Chinese Stock
If the stock was listed with a negative yield, prices would spike rapidly in exchange volumes. This would lead to greater volatility of the stock. As such, a market cap trade can come to significant risks, especially for U.S. investors. The high volatility of Chinese stocks is likely to bring about the risk of volatility of U.S. stocks. The probability of a trade war between the U.S. and China is a potential indicator of the possibility of a trade war between the U.S. and Chinese.
2.2. Potential of a Trade War Between the Company and the Stock
For every 100 shares of U.S. stock traded on the Chinese Stock Exchange, 100 of the shares traded on the U.S. stock exchanges would have increased their price to be more than the value and would be considered a trade sale
Risks to the Value of a Stock
1.A. The risks associated with risks to stocks as they relate to U.S. companies
The risk of being listed on U.S. or Chinese stock exchanges is a strong indicator of the potential for a significant trading deficit (Iyer.JW.S. 2017; Wiedemann.R.S. 2016). Stock volatility is often measured with a range of weights. There are few such scales (Zhang, Wu and Liao.R.S. 2013:11–18). Such a variation of weights would explain that, in the last few years of China’s history, stock price volatility has fallen on the Chinese Stock Exchange (Iyer.JW.S. 2016).
U.S. companies are a key player by being listed on the Chinese Stock Exchange, but are also dependent on the price volatility of their underlying Chinese company(s). There is also concern regarding a trade war between U.S and Chinese, as it is considered possible that these trading parties will be able to influence U.S. trading decisions to their advantage or against the wishes of U.S. and Chinese investors. U.S. companies have thus faced the option of being listed on exchanges across China. Thus, it would be prudent to assess risk of trading loss with the value of the stock itself.2. A trade war with the stock of any U.S. company would be highly speculative in the shortrun. Given the high cost and expense of any U.S. investment, the need to monitor the long term of a stock is likely to come in the form of an exchange report issued by the securities regulator in the U.S. This could lead to trade conflict. In order to assess the risks such a trade war would produce, it is likely that U.S. stock trades would have to be more volatile than before. This trade war will be a very stressful experience for U.S. shareholders.
2.1. Expected volatility of Chinese Stock
If the stock was listed with a negative yield, prices would spike rapidly in exchange volumes. This would lead to greater volatility of the stock. As such, a market cap trade can come to significant risks, especially for U.S. investors. The high volatility of Chinese stocks is likely to bring about the risk of volatility of U.S. stocks. The probability of a trade war between the U.S. and China is a potential indicator of the possibility of a trade war between the U.S. and Chinese.
2.2. Potential of a Trade War Between the Company and the Stock
For every 100 shares of U.S. stock traded on the Chinese Stock Exchange, 100 of the shares traded on the U.S. stock exchanges would have increased their price to be more than the value and would be considered a trade sale
Systematic risk is the risk inherent in the business environment, which consisted by market risk, credit risk, and liquidity risk (Don M, C. 2016). Because non-systematic risk, also known as non-financial risks that relate to organisation inherent risks, such as operation risk or solvency risk can be transferred or shift to other parties or by financial derivatives (Don M, C. 2016). Hence, only systematic risks are priced and compensate to the investor.
There is four characteristic associated with systematic risk (Don M, C. 2016.).1.Objectively, systematic risk obstinately exists and unable to diversified.2.Complexity, systematic risk is consists of multiple factors include in both macroeconomic and microeconomic, domestic interest rate, exchange rate, inflation, business cycle, political and so forth.
3.Systematic risk indicates a lost.4.Uncertainty, investors is unable to predict the risks of the market precisely and the severity when it occurs.In CAPM model, term Beta is to use to measure systematic risk, where systematic risk depends on the correlation between the asset and the market. Therefore, Beta is indicating the movement of securities relate to market move and how do securities correlate to the market. In addition to Beta, Fama and French also suggest that the systematic risk factor would also account the relative size of the company and relative book-to-market value of the enterprise (Fama and French, 1992). The study of Fama and French also found that the past returns could be explained better with their model than with other models available at that time, this is the most notably, the capital asset pricing model. Those factors mentioned above is known as three factor of return generate model of CAPM. However, the simplest and widely used return generate model is the single-index model, which only systematic risk, beta is considered, expressed by following formula.
The single-index model indicates that the expected return of security is risk-free rate add to the sensitivity of the security relate to market Multiply by the risk premium. The expression is simple, and only indicated the systematic risks.
The CAPM has following assumption to make the model validate (L, John. 1965).1.The investor is risk-averse, utility-maximising, and rational individuals.2.Markets are frictionless, including no transaction costs and no taxes.3.Investors plan for the same single holding period.4.Investors have homogeneous expectations or beliefs.5.All investments are infinitely divisible.6.The investor is price takers.However, as CAPM from a single-index model is to give an investor early