Sign Up Now
Get instant access to over 1 million+ study documents
OR
Already registered? click here to login
By creating your account, you agree to our terms of service, privacy policy and student honor code.
CAPM
For each of the scenarios below, explain whether or not it represents a diversifiable or undiversifiable risk. Explain your reasoning a. It is announced that a company is under investigation from the federal government for fraudulent accounting practices.
This represents a diversifiable risk. This risk is unsystematic and is unique to the company that is under investigation. Hopefully, if this stock was part of a portfolio, the effect of this risk will be relatively small on the overall value of the portfolio.
A major terrorist attack occurs in the U.S. again.
A terrorist attack would be an undiversifiable risk. The consequences of the attack would ripple through the entire economy and would influence a large number of assets. This market risk is systematic and can't be eliminated by diversification.
c. A large increase in the price of oil.
Although this development might affect...
This news would definitely affect oil companies and their suppliers and customers. Yet, companies not in the oil business might not be affected and therefore the risk is unsystematic. By diversifying assets between industries, an investor can mitigate risk.
d. The CEO of a major corporation is involved in a sex scandal.
This is another example of diversifiable risk. The sex scandal would likely only affect the one company. Overall, this risk would be easily diversified over an entire portfolio. This risk is definitely systematic.
2. Use the CAPM to answer the following questions:
a. Find the Expected Return on the Market Portfolio given that the Expected Return on Asset I is 5%, the Risk-Free Rate is 2%, and the Beta for Asset I is 1.5.
E (I) =.02 + [(.05-.02) * 1.5] =.065 = 6.5% b. Find the Risk-Free Rate given that the Expected Return…
Investopedia, a noteworthy financial website designed by Forbes Media and aiming to sustain investing decisions, defines the cost of equity as "the return that stockholders require for a company […]. A firm's cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership." The CAPM equitation: ra = rf + ?a x (rm - rf) (Investopedia) In our scenario, the risk
Capital Asset Pricing Model and Arbitrage Pricing Theory: Capital Asset Pricing Model (CAPM) is an arithmetical theory that describes the relationship between risk and return in a balanced market. The Capital Assets Pricing Model was autonomously and simultaneously developed by William Sharpe, Jan Mossin, and John Litner. The researches of these founders were published in three different and highly respected journal articles between 1964 and 1966. Since its inception, the model
The CAPM is useful to investors from two standpoints -- time value of money and the risk associated with the money invested. The time value of money is revealed by the free rate risk and represents the compensation investors will receive for having invested their money in the respective share, for a specific period of time. The risk of the investment is revealed by the second part of the
Capital Asset Pricing Model (CAPM) Basically, a diversifiable risk can be taken to be that risk which is largely limited to a given sector or security. On the other hand, a risk which affects the entire assets or liabilities class is referred to as an un-diversifiable risk. While it is possible to eliminate or reduce a diversifiable risk through diversification, the same cannot be utilized when it comes to the elimination
Finance There are three different models that can be used to estimate a company's cost of capital. Basically, each of these three is used to estimate the cost of equity. The cost of debt is usually calculated on the basis of the current weighted average of the yield to maturity on the company's debt. Thus, it is the cost of equity that must be calculated. The cost of equity reflects the
Finance Assessing WalMart Cost of Equity Cost of Equity Using CAPM To calculate the cost of equity using the capital asset pricing model (CAPM), the equation requires collection of some data regarding the firm and the market. The equation tells us what data is needed, the equation is cost of equity = RF + ?(RM - RF). RF is the risk free rate, RM is the return on a market portfolio, and ?