The Use of Capital Asset Pricing Model at Tullow Oil Free Essay Example, 1500 words

The return of a portfolio is a weighted average return of all the stocks present in our portfolio. In our case there are three shares in our portfolio, therefore, the return will be the weighted average rate of return of the three stocks. In the absence of any pre-defined weights, we are assuming to allocate equal weight to all stocks present in the portfolio. There is also a fact that Gilt securities are government BONDS and are fixed income securities. They technically zero-coupon bonds offered at discount and pay face value at the maturity whereas stocks do not have any maturity and they don t offer fixed returns in case of common shares. It is because of this that a direct relationship or comparison can not be made. However, by evaluating the risk-return profile of Tullow s stock, we can safely assume that Tullow s stock is more volatile than that of Gilt and offers much higher returns than the Gilt is offering in the market. Portfolio risk is a different consideration and is no t a linear function as portfolio returns are. It is therefore considered that Portfolio risk is difficult to comprehend especially when the number of stocks in the portfolio increases. We will write a custom essay sample on The Use of Capital Asset Pricing Model at Tullow Oil or any topic specifically for you Only $17.96 $11.86/pageorder now The basic tenets of Risk Management suggest that it is not wise to look into the risk and return profile of just one stock bur rather investors should invest in multiple stocks so that a degree of diversification is achieved and risk is minimized. (McClure). The model which has been used to evaluate the risk and return profile of this stock is the Capital Asset Pricing Model or CAPM. The CAPM model works under certain special conditions. The first condition outlined under this model suggests that the individuals are risk-averse in nature, therefore, they will maximize their end period wealth. The second very critical weakness of this model is the fact that CAPM outlines that all the investors have uniform information and thus every information is available to the investors which often not the case.