Definition of corporate finance:Corporate finance is different
form business finance. Business finance refers to the finance of
all kinds of business that is sole traders. Partnership firms,
joint stock companies. Corporate finance means only the finance of
joint stock companies. So, we can say that corporate finance is the
process of decision making, planning, project setting, according to
the different portfolio of investment.From the above discussion we
have to find some question to know about corporate finance:1.
Should the firm launch a new product?2. Which supplier have to
choose for the firm?3. Should the firm produce a part of the
product or outsource production?4. Should the firm issue a new
stock or borrow money instead?5. How can the manager raise money
for start-up firm?
Capital Asset pricing model (CAPM)The model explaining the risk
return relationship is called capital asset pricing model. It
provides that in a well-functioning capital market, the risk
premium varies in direct proportion to risk.According to Charles P.
Johns- Capital asset pricing model relates the required rate of
return for any security with the risk for that security as measured
by beta.According to Robert,Capital Asset pricing model is a theory
which purposes to describe the structure of security prices where
all investors in the economic system are presumed to hold efficient
portfolios in expected return, variance space.From the above
discussion, it can be said that CAPM model is the model which
provides a measure of risk and method of estimating the market risk
return line.
Ki= Risk free rate +Risk Premium= +Here,Ki= the required rate of
return of an asset.= The Expected rate of return on the market
portfolio. The beta co-efficient for asset.= Risk free rate.
Assumptions of CAPM:There are some assumptions of CAPM:1. No
transaction cost, i.e. there is no cost of buying or selling any
asset.2. No taxes: there are no personal income taxes that is
investors are indifferent between capital gain and dividends.3.
Infinitely divisively assets: this means that investors could take
any positions in on investment, regardless of the size of their
wealth.4. Perfect competition: there are many investors and no
single investor can affect the price of a stock through his or her
buying and selling decisions.5. Single time period:all investors
decisions are based on single time period.6. Unlimited short sells:
the individual investor can sell short any amount of shares.7.
Unlimited lending and borrowing: all investors can borrow and lend
any amount of money at the risk free rate of return.
Formulas:
Expected return/Equilibrium return:= +Here,Ki= the required rate
of return of an asset.= The Expected rate of return on the market
portfolio. The beta co-efficient for asset.= Risk free rate.
Beta with co-variance:
Here, Variance of market return. covariance between stock i and
market portfolio.
