Capital Asset Pricing Models and Discount Price Flow Knowing the risk of an investment and understanding how that risk will affect future returns are aspects crucial to deciding whether the expected return is worth the risk. The Capital Asset Pricing Model (CAPM) provides a basis from which both risk and the effects of risk are determined by the investor while the Discounted Price Flow Model (DPCM) can help the investor decide how much amount he or she is willing to invest in a company in anticipation of expected future cash flows. As stated in the previous paragraph, the Capital Asset Pricing Model is a tool used to determine the risk of an investment and, in turn, decide whether the risk is worth the investment. The CAPM generally promotes the idea that not all risks are considered when determining the value of an asset; in fact, through diversification, part of the risk can be eliminated. The CAPM starts from the idea that there are two main risks involved in investing: systematic and unsystematic. Systematic risks are those risks, such as interest rates, that cannot be eliminated through diversification. Non-systematic risks are those risks inherent in specific types of stocks. As the individual investor builds their portfolio, the risks decrease. Because systemic risks are the ones that cause investors the most anxiety, and as a way to calculate those systemic risks, William Sharpe created the CAPM. With the recent spate of financial scandals, the discount flow model has taken on new importance. DPFM is used to determine the value of a company based on expected future cash flows. Projected free cash flows are discounted to present value using the company's weighted average costs of capital. ... middle of paper ... basically an investment in a company's debt. It is more or less a company's IOU with a fixed rate of return and principal repayment at maturity. For example, if Company A holds a $1,000 bond that pays 5% interest per year, it would receive 5% of $1,000 each year and its $1,000 back on the maturity date. A good deal right? Wrong. Having that 5% fixed rate isn't going to generate a lot of capital that a business can use for its needs. So, what would be most beneficial for a particular company? I would recommend stocks if the goal is short-term capital needs. Stocks, while relatively volatile, are easily liquidated and provide much more capital. I would only recommend bonds if the company's capital needs are not immediately needed. Bonds provide greater stability and REFERENCES Investopedia http://www.investopedia.com/articles. April extract 28, 2007