As we shall see, the APT played a more important role in asset-pricing theory in the following decade. .
The capital asset pricing model for this scenario suggests that annual returns on low-beta electric utility might be .05 + .50 beta (.065) = 8.25%. About 75% of this might come from dividends and the balance from expected growth in dividends over an extended time period. By contrast, an average stock with a beta of 1.00 should provide a rate of return of 4.5 to 5.0% plus the market premium of 6.5% or between 11 and 12%. .
Since stocks are bought on the basis of expected returns for the next year (or for several years into the future), a perceived shift in the rate of inflation (or of the interest rate level) will send most common stocks to higher or lower levels. Strength of the overall economy, the sector in which the firm operates, its own industry's strengths and weaknesses, and individual firm's characteristics likewise have a bearing on the assessed market value of equity issues. .
In general, the security market line, at a given point in time, appears to do a reasonably efficient job of explaining differences in expected yields on alternative types of financial issues. The capital asset pricing model is merely a graph showing the anticipated yields on securities traded in money and capital markets with varying degrees of financial risk. The trend line that joins the points on the graph is referred to as the security market line. Market yields are shown on the y (vertical) axis and the variability of return on the x (horizontal) axis. Alternatively, the average yields reported in current financial literature might be charted on the line and the approximate risk of variability read on the base. Let us illustrate the concept graphically with the following assumed yields: three-month T-bill yield of 5%, four-year T-note yield of 6%, twenty-year T-bond yield of 7.5%, AAA corporate long-term bond yield of 8%, fixed-rate mortgage yield of 8.
