Investment formula: The capital asset pricing model

Capital asset investment has been theorized to follow a model known as the capital asset pricing model (CAPM). It basically correlates the relationship between the risks and expected returns of capital assets and is mainly used in its pricing structure. The idea behind CAPM is that investors must be compensated for the time value of money and risks.

The time value of money relates to the compensations investors receive by placing money in any investment over a period while the latter is represented by the compensation received by the investor by taking on additional risks. The model further states that the expected return of a capital asset must equal the rate of the risk-free security plus a risk premium. If the risk-free security and the risk premium are higher, then the expected return must be higher as well and vice versa. If, however, the returns and the risks do not balance out, then the business venture should not be continued.

Other assumptions that are under the CAPM are that investors hold a diverse set of portfolios (a systematic return for the risk of their portfolios is the only requirement since unsystematic risk has been removed), that there is a single-period transaction horizon (the holding period commonly used is one year), that they can borrow and lend money at a risk-free rate of return, and that a perfect capital market exists (all securities hold a correct value and that their returns will be plotted on the security market line).

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A Beginner’s Guide To Capital Assets

There are a few varying definitions of capital assets. For this article, capital assets will refer to anything owned at a high value whether at a person’s home or in business, with a few exceptions.

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Image source: krombholzjewelers.com

Capital assets at home include the property itself, jewelry (made of gold or silver, with precious stones), automobiles, painting and sculptures or statues, rare books, mint-conditioned collectibles such as baseball cards, and other family heirlooms. More conventional objects, however, such as clothing, furniture, and appliances can be treated as capital assets when sold.

Capital assets in a company are treated and used differently from other objects in the office. For example, computers in a small company are treated as capital assets, but staplers, stapler bullets, pencils, and other office supplies are seen as consumable products. Office supplies only become assets if the company itself is an office supply store or a company of a similar nature.

Another important bit of information to note is that the statuses of computers are also varied. In small companies, as mentioned above, they are treated as capital assets. However, for larger companies with over 500 or more employees, ordinary desktop and laptop computers are consumable.

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Image source: wikipedia.org

Capital gains or losses is the profit or loss people incur when they sell their capital assets, on the basis of the actual selling price minus the owner’s projected selling price.

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Identifying and measuring key opportunities in the capital assets market

A capital asset is a type of asset that cannot be easily traded with cash, as what usually happens in an ordinary business operation. Its main role in businesses is to generate profit that will span a time frame of one year or longer. Examples of assets falling under this category are real estate, heavy machinery, and others that contribute directly to the core of the business operations. They are not usually exchanged for cash unless they are being traded for a newer model or a worst case scenario arises such as bankruptcy.

One of the more common types of capital assets is real estate. This covers the site in which the business operates. For example, a car manufacturing company will own and operate a car manufacturing plant that produces the automobiles under the company brand. The entire area that encompasses the plant will be continually used presumably for years or even permanently. The building and the land are considered as key assets in the business operations and therefore will not be sold unless it becomes a necessity for the continued lifespan of the company.

Another type of capital asset is heavy machinery and equipment. These heavy-duty devices can be used continually for many years, until such time that they are no longer usable or have to be replaced with a more advanced technology. They are mainly utilized by companies that specialize in the construction of tangible assets (such as cranes and concrete makers), harvesting of raw materials (such as farming equipment and drilling rigs), the manufacture of products (such as printing machines and ovens), and delivery of services (such as computers and vehicles).

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