Financial Terms Asset pricing model

# Definition of Asset pricing model

## Asset pricing model

A model for determining the required rate of return on an asset.

## Asset pricing model

A model, such as the Capital asset pricing model (CAPM), that determines the required
rate of return on a particular asset.

# Related Terms:

## Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security

## Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

## capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

## CARs (cumulative abnormal returns)

a measure used in academic finance articles to measure the excess returns an investor would have received over a particular time period if he or she were invested in a particular stock.
This is typically used in control and takeover studies, where stockholders are paid a premium for being taken over. Starting some time period before the takeover (often five days before the first announced bid, but sometimes a longer period), the researchers calculate the actual daily stock returns for the target firm and subtract out the expected market returns (usually calculated using the firmâ€™s beta and applying it to overall market movements during the time period under observation).
The excess actual return over the capital asset pricing model-determined expected return market is called an â€˜â€˜abnormal return.â€™â€™ The cumulation of the daily abnormal returns over the time period under observation is the CAR. The term CAR(-5, 0) means the CAR calculated from five days before the
announcement to the day of announcement. The CAR(-1, 0) is a control premium, although Mergerstat generally uses the stock price five days before announcement rather than one day before announcement as the denominator in its control premium calculation. However, the CAR for any period other than (-1, 0) is not mathematically equivalent to a control premium.

## Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

## Excess returns

Also called abnormal returns, returns in excess of those required by some asset pricing model.

## Foreign market beta

A measure of foreign market risk that is derived from the capital asset pricing model.

## Jensen index

An index that uses the capital asset pricing model to determine whether a money manager
outperformed a market index. The "alpha" of an investment or investment manager.

## Multifactor CAPM

A version of the capital asset pricing model derived by Merton that includes extramarket
sources of risk referred to as factor.

## Two-factor model

Black's zero-beta version of the capital asset pricing model.

## CAPM

See capital asset pricing model.

## economic components model

Abramsâ€™ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

## Gordon model

present value of a perpetuity with growth.
The end-ofyear Gordon model formula is: 1/(r - g)
and the midyear formula is: SQRT(1 + r)/(r - g).

## log size model

Abramsâ€™ model to calculate discount rates as a function of the logarithm of the value of the firm.

## QMDM (quantitative marketability discount model)

model for calculating DLOM for minority interests r the discount rate

## Acquisition of assets

A merger or consolidation in which an acquirer purchases the selling firm's assets.

IRS rules used to allocate income on export sales to a foreign sales corporation.

## Arbitrage-free option-pricing models

Yield curve option-pricing models.

## Asset

Any possession that has value in an exchange.

## Asset/equity ratio

The ratio of total assets to stockholder equity.

## Asset/liability management

Also called surplus management, the task of managing funds of a financial
institution to accomplish the two goals of a financial institution:
1) to earn an adequate return on funds invested, and
2) to maintain a comfortable surplus of assets beyond liabilities.

## Asset activity ratios

Ratios that measure how effectively the firm is managing its assets.

## Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

## Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts
on personal property, not real estate.

## Asset-based financing

Methods of financing in which lenders and equity investors look principally to the
cash flow from a particular asset or set of assets for a return on, and the return of, their financing.

## Asset classes

Categories of assets, such as stocks, bonds, real estate and foreign securities.

## Asset-coverage test

A bond indenture restriction that permits additional borrowing on if the ratio of assets to
debt does not fall below a specified minimum.

## Asset for asset swap

Creditors exchange the debt of one defaulting borrower for the debt of another
defaulting borrower.

## Asset substitution

A firm's investing in assets that are riskier than those that the debtholders expected.

## Asset substitution problem

Arises when the stockholders substitute riskier assets for the firm's existing
assets and expropriate value from the debtholders.

## Asset swap

An interest rate swap used to alter the cash flow characteristics of an institution's assets so as to
provide a better match with its iabilities.

## Asset turnover

The ratio of net sales to total assets.

## Assets

A firm's productive resources.

## Assets requirements

A common element of a financial plan that describes projected capital spending and the
proposed uses of net working capital.

## Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

## Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

## Constant-growth model

Also called the Gordon-Shapiro model, an application of the dividend discount
model which assumes (1) a fixed growth rate for future dividends and (2) a single discount rate.

## Current assets

Value of cash, accounts receivable, inventories, marketable securities and other assets that
could be converted to cash in less than 1 year.

## Deterministic models

Liability-matching models that assume that the liability payments and the asset cash
flows are known with certainty. Related: Compare stochastic models

## Discounted dividend model (DDM)

A formula to estimate the intrinsic value of a firm by figuring the
present value of all expected future dividends.

## Dividend discount model (DDM)

A model for valuing the common stock of a company, based on the
present value of the expected cash flows.

## Dividend growth model

A model wherein dividends are assumed to be at a constant rate in perpetuity.

## Dynamic asset allocation

An asset allocation strategy in which the asset mix is mechanistically shifted in
response to -changing market conditions, as in a portfolio insurance strategy, for example.

## Exchange of assets

Acquisition of another company by purchase of its assets in exchange for cash or stock.

## Extrapolative statistical models

models that apply a formula to historical data and project results for a
future period. Such models include the simple linear trend model, the simple exponential model, and the
simple autoregressive model.

## Factor model

A way of decomposing the factors that influence a security's rate of return into common and
firm-specific influences.

## Financial assets

Claims on real assets.

## Fixed asset

Long-lived property owned by a firm that is used by a firm in the production of its income.
Tangible fixed assets include real estate, plant, and equipment. Intangible fixed assets include patents,

## Fixed asset turnover ratio

The ratio of sales to fixed assets.

## Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

## Index model

A model of stock returns using a market index such as the S&P 500 to represent common or
systematic risk factors.

## Intangible asset

A legal claim to some future benefit, typically a claim to future cash. Goodwill, intellectual

## Liquid asset

asset that is easily and cheaply turned into cash - notably cash itself and short-term securities.

## Long-term assets

Value of property, equipment and other capital assets minus the depreciation. This is an
entry in the bookkeeping records of a company, usually on a "cost" basis and thus does not necessarily reflect
the market value of the assets.

## Limitation on asset dispositions

A bond covenant that restricts in some way a firm's ability to sell major assets.

## Market model

This relationship is sometimes called the single-index model. The market model says that the
return on a security depends on the return on the market portfolio and the extent of the security's
responsiveness as measured, by beta. In addition, the return will also depend on conditions that are unique to
the firm. Graphically, the market model can be depicted as a line fitted to a plot of asset returns against
returns on the market portfolio.

## Modeling

The process of creating a depiction of reality, such as a graph, picture, or mathematical
representation.

## Net asset value (NAV)

The value of a fund's investments. For a mutual fund, the net asset value per share
usually represents the fund's market price, subject to a possible sales or redemption charge. For a closed end
fund, the market price may vary significantly from the net asset value.

## Net assets

The difference between total assets on the one hand and current liabilities and noncapitalized longterm
liabilities on the other hand.

## Non-reproducible assets

A tangible asset with unique physical properties, like a parcel of land, a mine, or a
work of art.

## Other current assets

Value of non-cash assets, including prepaid expenses and accounts receivable, due
within 1 year.

## Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.

## Policy asset allocation

A long-term asset allocation method, in which the investor seeks to assess an
appropriate long-term "normal" asset mix that represents an ideal blend of controlled risk and enhanced
return.

## Pricing efficiency

Also called external efficiency, a market characteristic where prices at all times fully
reflect all available information that is relevant to the valuation of securities.

assets that can be traded in a public market, such as the stock market.

## Quick assets

Current assets minus inventories.

## Real assets

Identifiable assets, such as buildings, equipment, patents, and trademarks, as distinguished from a
financial obligation.

## Regulatory pricing risk

Risk that arises when regulators restrict the premium rates that insurance companies
can charge.

## Reproducible assets

A tangible asset with physical properties that can be reproduced, such as a building or
machinery.

## Residual assets

assets that remain after sufficient assets are dedicated to meet all senior debtholder's claims in full.

## Return on assets (ROA)

Indicator of profitability. Determined by dividing net income for the past 12 months
by total average assets. Result is shown as a percentage. ROA can be decomposed into return on sales (net
income/sales) multiplied by asset utilization (sales/assets).

## Return on total assets

The ratio of earnings available to common stockholders to total assets.

## Riskless or risk-free asset

An asset whose future return is known today with certainty. The risk free asset is
commonly defined as short-term obligations of the U.S. government.

## Risky asset

An asset whose future return is uncertain.

## Risk-free asset

An asset whose future return is known today with certainty.

## Single factor model

A model of security returns that acknowledges only one common factor.
See: factor model.

## Single index model

A model of stock returns that decomposes influences on returns into a systematic factor,
as measured by the return on the broad market index, and firm specific factors.

## Simple linear trend model

An extrapolative statistical model that asserts that earnings have a base level and
grow at a constant amount each period.

## Single-index model

Related: market model

## Stochastic models

Liability-matching models that assume that the liability payments and the asset cash flows
are uncertain. Related: Deterministic models.

## Tactical Asset Allocation (TAA)

An asset allocation strategy that allows active departures from the normal
asset mix based upon rigorous objective measures of value. Often called active management. It involves
forecasting asset returns, volatilities and correlations. The forecasted variables may be functions of
fundamental variables, economic variables or even technical variables.

## Tangible asset

An asset whose value depends on particular physical properties. These i nclude reproducible
assets such as buildings or machinery and non-reproducible assets such as land, a mine, or a work of art. Also
called real assets. Related: Intangible asset

## Total asset turnover

The ratio of net sales to total assets.

## Two-state option pricing model

An option pricing model in which the underlying asset can take on only two
possible (discrete) values in the next time period for each value it can take on in the preceding time period.
Also called the binomial option pricing model.

## Underlying asset

The asset that an option gives the option holder the right to buy or to sell.

## Underpricing

Issue of securities below their market value.

## Value-at-Risk model (VAR)

Procedure for estimating the probability of portfolio losses exceeding some
specified proportion based on a statistical analysis of historical market price trends, correlations, and volatilities.

## Wasting asset

An asset which has a limited life and thus, decreases in value (depreciates) over time. Also
applied to consumed assets, such as gas, and termed "depletion."

## Yield curve option-pricing models

models that can incorporate different volatility assumptions along the
yield curve, such as the Black-Derman-Toy model. Also called arbitrage-free option-pricing models.

## ASSETS

Anything of value that a company owns.

## Current assets

Cash, things that will be converted into cash within a year (such as accounts receivable), and inventory.

## RATE OF RETURN ON TOTAL ASSETS

The percentage return or profit that management made on each dollar of assets. The formula is:
(Net income) / (Total assets)

## Cost-plus pricing

A method of pricing in which a mark-up is added to the total product/service cost.

## Current assets

Amounts receivable by the business within a period of 12 months, including bank, debtors, inventory and prepayments.

## Fixed assets

Things that the business owns and are part of the business infrastructure â€“ fixed assets may be
tangible or intangible.

## Intangible fixed assets

Non-physical assets, e.g. customer goodwill or intellectual property (patents and trademarks).

## Tangible fixed assets

Physical assets that can be seen and touched, e.g. buildings, machinery, vehicles, computers etc.