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CAPM

The document discusses different approaches to managing risk including insurance, mutual funds, hedge funds, arbitrage, and derivatives. It also covers concepts related to investment funds such as hurdle rates, high water marks, and claw backs. Finally, it provides overviews of capital asset pricing model (CAPM), arbitrage pricing theory (APT), distressed securities, and hybrid financing.

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Haziq Abbasi
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5 views

CAPM

The document discusses different approaches to managing risk including insurance, mutual funds, hedge funds, arbitrage, and derivatives. It also covers concepts related to investment funds such as hurdle rates, high water marks, and claw backs. Finally, it provides overviews of capital asset pricing model (CAPM), arbitrage pricing theory (APT), distressed securities, and hybrid financing.

Uploaded by

Haziq Abbasi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Approaches to risk

1. Risk Transfer: This involves transferring the financial consequences of a risk to another party.
Insurance is a common method of risk transfer, where individuals or businesses pay premiums
to an insurance company in exchange for coverage against potential losses.
2. Loss Control: Loss control refers to measures taken to prevent or minimize losses. This can
include implementing safety protocols, conducting risk assessments, and adopting risk
management strategies. Financial options can also be used as a form of loss control, allowing
individuals or businesses to hedge against potential financial risks.
3. Risk Reduction: Risk reduction aims to decrease the probability or impact of a risk. Arbitrage
and hedging are strategies used to reduce risk. Arbitrage involves taking advantage of price
differences in different markets, while hedging involves using financial instruments to offset
potential losses.
4. Risk Retention: Risk retention involves accepting and managing the potential risks without
transferring them to another party. Delaying insurance is one way to retain risk, where
individuals or businesses choose not to purchase insurance immediately and instead bear the
financial consequences themselves.
5. Risk Separation: Risk separation involves diversifying or splitting risks to minimize their
impact. Diversification refers to spreading investments across different assets or sectors to
reduce the impact of a single risk. Buyouts and stock splits are other examples of risk
separation strategies.

When it comes to managing risk, there are various approaches you can consider:
1. Insurance and Pension Plans: Insurance provides protection against potential losses by
transferring the risk to an insurance company. Pension plans, on the other hand, help
individuals save for retirement by providing a steady income stream.
2. Mutual Funds: Mutual funds pool money from multiple investors to invest in a diversified
portfolio of stocks, bonds, or other assets. This diversification helps spread the risk and can be
a more accessible way for individuals to invest in the market.
3. Hedge Funds: Hedge funds are investment funds that use various strategies, such as
leveraging, short selling, and derivatives, to aim for higher returns. They can be more complex
and typically cater to accredited investors.
4. Arbitrage: Arbitrage involves taking advantage of price differences in different markets to
make a profit with little to no risk. Traders exploit temporary imbalances in prices to buy low and
sell high, making a profit from the price discrepancy.
5. Options and Derivatives: Options and derivatives are financial instruments that derive their
value from an underlying asset. They can be used to hedge against price fluctuations, speculate
on market movements, or manage risk in various ways.

1. Hurdle Rates: Hurdle rates are minimum rates of return that an investment must achieve
before the fund manager is eligible to receive performance-based compensation, such as a
performance fee or carried interest. It acts as a benchmark that the investment needs to
surpass to trigger additional compensation for the fund manager.
2. High Water Marks: High water marks are a mechanism used to ensure that fund managers
only receive performance fees on new profits generated after any previous losses have been
fully recovered. It sets a peak value that the fund's net asset value (NAV) must surpass before
performance fees can be charged again.
3. Claw Backs: Claw backs are provisions that allow investors to recoup previously paid
performance fees from the fund manager under certain circumstances. For example, if the
fund's performance declines after the performance fees have been paid, the fund manager may
be required to return a portion of those fees to the investors.
4. Distress securities, also known as distressed debt or distressed assets, refer to financial
instruments or assets that are experiencing financial difficulties or are at risk of default. These
securities are typically issued by companies or entities that are facing financial distress, such as
bankruptcy or significant financial challenges

CAPM
1. It means the capital asset pricing model
2. CAPM is based on an investor's portfolio demand and equilibrium arguments.
3. It is based on risk-return trade-off
4. It is difficult to find a good proxy for market return.
5. It has a simple beta.
6. CAPM is a single factor model
7. CAPM requires that the market portfolio be efficient.
8 CAPM assumes that the probability distributes of asset returns are normally distributed.
APT
1. It means arbitrage pricing theory.
2. APT is based on the factors model of returns and the approximate arbitrage arguments.
3. It is based on mathematical and statistical data theory.
4. It is difficult to identify approximate factors.
5. It has several relevant data.
6. APT is a multifactor model.
7. There is no special role in the market portfolio in APT
8. APT does not make any assumption about the distribution of asset returns.
Hybrid financing combines different types of funding to meet a company's specific needs. It blends debt
and equity to create a customized financing structure. It's a flexible approach that can benefit
companies by balancing the advantages of both debt and equity.

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