Chapter 1

           “The Arithmetic of Active Management”

 “Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.”  William Sharpe

The Capital Asset Pricing Model revolutionized the understanding of asset pricing within the investment valuation sector. The model provided a framework to understand expected return and risk articulating the difference between systematic and unsystematic risk. CAPM lays down a simplistic approach to valuing risky assets by measuring the systematic risk of an asset. CAPM does not need to work on deriving free cash flows of an asset but rather an understanding of a firm’s systematic risk with the benchmark index and the market premium associated with the asset. CAPM measures asset pricing based on systematic risk defined as beta of an asset. As we advance in this course, all concepts will be discussed in detail.

Video: CAPM | The middle Road 
  • Quantifies and simplifies risk of risky asset classes
  • Forward looking and lays down the expected fair price of the risky assets
  • Measures systematic risk of the risky asset
  • Defines a hurdle rate which works as a reference point to understand profitability of  cash flows
  • Promotes passive investment