Large Fire Damages Three Major

¶ … large fire damages three major U.S. cities is a diversifiable risk. While this type of risk is so unlikely as to not be expected, the risk itself is geographic risk. It is only three specific geographies that are affected, rather than the entire planet. In this case, geographic diversification would have mitigated the damage to the portfolio because the account would still be invested outside of those three cities.

b) A substantial unexpected rise in the price of oil is a systemic risk to the extent that it will affect a wide swath of the economy. It would be unreasonable to expect that the portfolio would be completely hedged against such an outcome, given that a rise in the price of oil would impact so many consumers and companies to the extent that it would affect overall economic performance. That said, this type of risk can at least be partially diversified.

There are firms that benefit from an increase in oil prices. Thus, this risk can at least be partially diversified away. To fully diversify this type of risk would leave the portfolio exposed to other types of risk. A fully diversified portfolio, therefore, would be exposed to at least some degree of risk of an increase in oil prices. c) A lawsuit against one company can be diversified away. This risk is firm-specific. Thus, a fully diversified portfolio would negate this particular risk from impacting the portfolio overall. Part II.

a) CAPM states that Ra = Rf + B (Rm -- Rf) Therefore, in this circumstance, CAPM shows as follows: 10 = 3 + 1.5(Rm -- 3) Rm -- 3 = 4.667; therefore Rm = 7.667. b) Under this circumstance, CAPM shows as follows: 14 = Rf + 1.5 (12 -- Rf) 14 -- Rf = 18 -- 1.5Rf .5Rf = 4 Rf = 8 c) If I owned half of the stocks on all the major stock exchanges, the beta of the portfolio would be 1. The portfolio should be expected to be perfected diversified with such a high amount of holdings.

A perfectly diversified portfolio would trade in line with the market, and would therefore have a beta of 1. 3. The main message of CAPM to corporations is that the payoff of each investment they make should be made with risk level in mind. Executives are faced with a wide range of investment possibilities every day. The expected payoff of each of these activities, however, is subject to certain risk factors.

A careful analysis of these risk factors must be carefully considered in order to understand the value of the investment relative to the risk that is being undertaken. It is not simply the expected return of a capital asset that must be considered. The risk level of that asset is an integral component of the decision-making process. Riskier investments.