EFG (CAPM) Theory
The Innovation Token of Financial
The previous, ECOC Financial Growth (EFG) discussed The Modern Portfolio Theory (MPT) theory used to evaluate an investment in portfolios, so this article continues with presented The Theory Capital Asset Pricing Models. (CAPM) is a tool that determines the expected return and risk of each asset, taking into account the risk-free ratio, Systematic risk, and Unsystematic risk. In traditional finance, they believe that there are assets with a positive ROI and no risk. They often label the asset as a positive short-term bond. So, we have:
• Risk-free rate Rrf
• Systematic risk Rm
• Risk of the asset Ra
• Coefficient βa between the asset and the market performance
and the formula:
Ra = Rrf + βa ∗ (Rm − Rrf )
β is given by the equation:
βa = Cov(Ra, Rm)
V ar Rm
Discusses risks or “Uncertainties” It occurs when an investor unknow for sure what will happen in the future or the opportunity that the actual return is below the return that investors expect. Due to various reasons Most investors try to avoid risk or minimize the risk.
Besides, each investor can accept different risks. It depends on the preferences, attitudes, and motivations of each investor. When choosing an investment that offers good returns, investors should also consider investment risks as they are the least mistaken investments. Typically, investors can analyze risk from two main types of risks involved in investing in securities.
Systematic risk is a change in the return on an investor’s investment. Caused by changes in the external environment of the business Which is not controllable and has an impact on all market prices. Which when it occurs, the prices generally change in the same direction.
Such as, stock exchange risks are risks arising from loss of investment. This is the result of changes in the prices of stocks and various assets in the market because the securities prices fluctuate all the time, there is a chance of loss or loss due to the movement of stock prices on the stock market. The change in stock prices on the stock exchange is not related to the intrinsic valuation of the securities, although the profitability of an entity does not change. But the price of the securities depends on the Demand and Supply of each type of securities in the market that is beyond the control of the company, including the war, the year of election of the country’s executives. Political policies, speculation, etc. that occur in the stock market and this change in stock prices are caused by investors’ predictions on the progress of that company.
Unsystematic risk is the risk that arises in a specific some of the business operations. Which, when any event occurs, will affect the price of that business only. But they will not affect with other securities in the market, these risks are classified as unsystematic such as:
• Financial Risk It is the risk that an investor has the opportunity to lose his money, such as an investor decides to invest in a particular company. And if the issuing company does not have paid for debt repayment and resulting in the companies that investors have invested in You must file bankruptcy.
• Administrative Risk It is the risk arising from management’s work, such as management mistakes or mistakes in the investment decisions of the management
• Industrial risks It is a risk posed by some of the impetus that all businesses in the same industry or certain industries are affected.
Therefore, the hypothesis of the CAPM theory is that all investors are seeking the greatest benefit that they can expect from their own assets. By choosing to invest based on returns including risk factors and considering whether investors are afraid of risk or not investors should choose to invest for the benefit of diversification. When an investor wants to invest in a certain asset for investment, they at least need to have a basic knowledge of it, such as what assets to buy, how much risk or return on investment?
For the cryptocurrency market, which EFG is interested in, as systemic risk, is we can safely assume a sharp decline in the prices of the leader coins (BTC, ETH) relative to fiat money or to a stable coin. Because covariance ρ of all crypto assets (except stablecoins) is close to 1, if the leader coins crash, we expect with a very high probability all cryptos to follow. Systematic risk in our case represents the probability of the whole crypto market system failing.
Picture showing the relationship between the risk and the amount of securities
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