Question.2423 - DQ1 Assessment Description Compare the capital asset pricing model with the Fama-French (FF) 3-factor model. Describe the function and impact of each risk factor. DQ2 Assessment Description Explain what is meant by the terms "efficient market" and "inefficient market" and describe any implications market efficiency might have on an investor's approach to investing.
Answer Below:
DQ1 Capita Asset Pricing Model (CAPM) is the foundation of the modern portfolio hypothesis to regulate the required rate of return of stocks so that the adding of stock can be determined well. The Fama and French three model factor is an analytical method designed by Eugene Fama and Keneth French to assess stock returns. This method is an enlarged feature in comparison to that of CAPM.s risk factor as it adds size risk and value risk. This model reviews the performance of small-cap stocks. The Fama and French three-factor model approached and measured equity returns distinguishing and finding the value stocks that create growth and also small-cap stocks perform well in comparison to large-cap stocks. Thus, portfolios with a large number of small-cap or value stocks are better than the ones with large-cap but lower CAPM results. This is because the three-factor model makes adjustments and values the performance of small-cap stocks. This is why the three factor-model is considered to be better than CAPM. The Capital Asset Pricing Model is a simple variable method that evaluates the cost of equity. The CAPM method reviews the rate of return required based on the level of risk associated with the investment. It also reviews the additional returns the investors can put more than a risk-free rate in comparison to market risk("Analysis of CAPM and Three Factor Model", 2017). 3 DQ 2 The precise price of a stock or other investment at any given time is an Efficient Market Theory. The theory of an efficient market states that if participants of the market have the same information, then price differences between markets will not avail anymore. On the other hand, an inefficient market is one in which prices of assets swing both sides by market players. According to market theory, the difference between an inefficient market and an efficient market depends upon how sensible the investors are and how good the information is available to them. The inefficient market prevails due to the availability of less-worthy information and slower spreading of the same. Sharp falls in the market during panics are evidence that the equity market is an inefficient market. The implication of EMH is that investors shouldn't be able to defeat the market because all information that could indicate enactment is available in the stock price. It is assumed in EMH that stock prices observe a random hike, based on the current day's news rather than past moves. As the grade and quantity of data upsurge, the market becomes more efficient reducing options for the intervention of above-market returns. The efficient market hypothesis is divided into three different interpretations: weak, semi-strong, and strong ("Efficient & Inefficient market", n.d.). References Analysis of CAPM and Three Factor Model. (2017). Retrieved 23 March 2022, from https://www.ukessays.com/essays/economics/analysis-capm-factor-model- 4554.php#:~:text=Unlike%20CAPM%20which%20is%20a,book%20to%20market%20based%20factor. Efficient & Inefficient market. Retrieved 23 March 2022, from https://saylordotorg.github.io/text_personal- finance/s17-behavioral-finance-and-market-.htmlMore Articles From Finance
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