What is the Capital Asset Pricing Model

The United States Securities and Exchange Commission has issued a cease and desist order against CoinAlpha Advisors LLC in addition to ordering a $50,000 penalty, according to a filing published Dec. 7.

Delaware-registered CoinAlpha Advisors LLC was reportedly established in July 2017 to act as the managing member of and manager to fund CoinAlpha Falcon LP, which was formed in October 2017.

By May 2018, the fund had allegedly raised over $600,000 from 22 investors from at least five states, which purchased limited partnership interests in the fund in exchange for a proportional share of any profits derived from the fund�s investment in digital assets.

Although CoinAlpha Advisors filed a Notice of Exempt Offering of Securities with the SEC on Nov. 3, 2017, the company was not registered with the SEC. Therefore, CoinAlpha Advisors violated the securities law that �prohibits the sale of securities through interstate commerce or the mails unless a registration statement is in effect.�

Per the file, CoinAlpha Advisors immediately halted the offering once it was contacted by the SEC and undertook a review of marketing and promotional materials posted on social media. The company also reimbursed all fees it had already collected and resigned all rights to future management and incentive fees.

Now, CoinAlpha Advisors reportedly has to pay a civil money penalty in the amount of $50,000 within ten days of entry of the order.

Yesterday, the SEC set a new deadline for Feb. 27, 2019, in order to further review the rule change proposals to list a Bitcoin exchange-traded fund ETF by investment firm VanEck and blockchain company SolidX on the Chicago Board Options Exchange.

Both VanEck and SolidX firms filed with the SEC to list a Bitcoin-based ETF on June 6. Subsequently, in August, the commission delayed its decision on listing the ETF until Sept. 30, requesting further comments regarding the decision. In October, the SEC set a deadline for submitting comments about proposed rule changes related to a number of applications for Bitcoin ETFs.

 BREAKING DOWN Capital Asset Pricing Model - CAPM

The formula for calculating the expected return of an asset given its risk is as follows


Investors expect to be compensated for risk and the time value of money. The risk-free rate in the CAPM formula accounts for the time value of money. The other components of the CAPM formula account for the investor taking on additional risk.

The beta of a potential investment is a measure of how much risk the investment will add to a portfolio that looks like the market. If a stock is riskier than the market, it will have a beta greater than 1. If a stock has a beta of less than one, the formula assumes it will reduce the risk of a portfolio.



A stock�s beta is then multiplied by the market risk premium, which is the return expected from the market above the risk-free rate. The risk-free rate is then added to the product of the stock�s beta and the market risk premium. The result should give an investor the required return or discount rate they can use to find the value of an asset.
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The goal of the CAPM formula is to evaluate whether a stock is fairly valued when its risk and the time value of money are compared to its expected return.

For example, imagine an investor is contemplating a stock worth $100 per share today that pays a 3% annual dividend. The stock has a beta compared to the market of 1.3, which means it is riskier than a market portfolio. Also, assume that the risk-free rate is 3% and this investor expects the market to rise in value by 8% per year.

The expected return of the stock based on the CAPM formula is 9.5%.
 Problems with the CAPM

There are several assumptions behind the CAPM formula that have been shown not to hold in reality. Despite these issues, the CAPM formula is still widely used because it is simple and allows for easy comparisons of investment alternatives.

Including beta in the formula assumes that risk can be measured by a stock�s price volatility. However, price movements in both directions are not equally risky. The look-back period to determine a stock�s volatility is not standard because stock returns are not normally distributed.

The CAPM also assumes that the risk-free rate will remain constant over the discounting period. Assume in the previous example that the interest rate on U.S. Treasury bonds rose to 5% or 6% during the 10-year holding period. An increase in the risk-free rate also increases the cost of the capital used in the investment and could make the stock look overvalued.

The market portfolio that is used to find the market risk premium is only a theoretical value and is not an asset that can be purchased or invested in as an alternative to the stock. Most of the time, investors will use a major stock index, like the S&P 500, to substitute for the market, which is an imperfect comparison.

The most serious critique of the CAPM is the assumption that future cash flows can be estimated for the discounting process. If an investor could estimate the future return of a stock with a high level of accuracy, the CAPM would not be necessary.

The CAPM and the Efficient Frontier

Using the CAPM to build a portfolio is supposed to help an investor manage their risk. If an investor were able to use the CAPM to perfectly optimize a portfolio�s return relative to risk, it would exist on a curve called the efficient frontier.