Provide intuition for the asset pricing equation: Pt = Et (Mt+1Xt+1) where M is the stochastic discount factor and X is tomorrow's return on the asset. Calculus is not required but you should provide graphical intuition.

Provide intuition for the asset pricing equation: Pt = Et (Mt+1Xt+1) where M is the stochastic discount factor and X is tomorrow's return on the asset. Calculus is not required but you should provide graphical intuition.

Managerial Accounting: The Cornerstone of Business Decision-Making

7th Edition

ISBN:9781337115773

Author:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Publisher:Maryanne M. Mowen, Don R. Hansen, Dan L. Heitger

Chapter12: Capital Investment Decisions

Section: Chapter Questions

Problem 10DQ: What is the role that the required rate of return plays in the NPV model? In the IRR model?

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Concept explainers

Risk and return

Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.

Capital Asset Pricing Model

Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.

Question

Provide intuition for the asset pricing equation: P
Et (M+1 Xt+1)
where M is the stochastic discount factor and X is tomorrow's return on the asset. Calculus is not
required but you should provide graphical intuition.

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