CAPM: Finance Mod 3 Case

Finance Mod 3 Case
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Finance Mod 3 Case
To begin with, it is crucial to understand the difference between diversifiable and undiversifiable risks because the two terms lay the foundation for the upcoming discussion. It follows that a diversifiable risk affects a particular company, while an undiversifiable risk affects the entire economy (Sanghera, 2011). As a result, firms can control diversifiable risks, but cannot control undiversifiable risks. This reveals that a substantial increase in the rate of inflation is undiversifiable, because it affects all firms. Additionally, inflation cannot be controlled by an organization.
A major recession in the United States of America is also undiversifiable, because it would affect all firms within the country. Further, a specific firm cannot control recession. However, multinational corporations within the America could be in a position to limit the effects of recession using their branches from different countries. In Short, A major recession in America would be undiversifiable for local companies, but would be diversifiable for multinational companies. Finally, a major lawsuit against a large and publicly traded organization is a diversifiable risk because it only affects one company. Therefore, investors can avoid making losses by investing in different stocks or investment vehicles.
The expected return is given by
Expected return = Riskfree rate + (Market return - Riskfree rate) × Beta (Vollmer, 2014).
Therefore,
Expected return = 4% +(12%-4%)*1.2
Expected return =14%
From the formula above, we can derive the Risk free rate as shown below
Expected return = Riskfree rate+Market return*Beta- Riskfree rate*Beta
Expected return- Market return*Beta= Riskfree rate- Riskfree rate*Beta
Riskfree rate= (Expected return- Market return*Beta)1-Beta
Therefor...