2 pages/≈550 words
Accounting, Finance, SPSS
CAPM: Finance Mod 3 Case (Essay Sample)
- For each of the scenarios below, explain whether or not it represents a diversifiable or an undiversifiable risk. Please consider the issues from the viewpoint of investors. Explain your reasoning.
- There's a substantial unexpected increase in inflation.
- There's a major recession in the U.S.
- A major lawsuit is filed against one large publicly traded corporation.
- Use the CAPM to answer the following questions:
- Find the Expected Rate of Return on the Market Portfolio given that the Expected Rate of Return on Asset "i" is 12%, the Risk-Free Rate is 4%, and the Beta (b) for Asset "i" is 1.2.
- Find the Risk-Free Rate given that the Expected Rate of Return on Asset "j" is 9%, the Expected Return on the Market Portfolio is 10%, and the Beta (b) for Asset "j" is 0.8.
- What do you think the Beta (β) of your portfolio would be if you owned half of all the stocks traded on the major exchanges? Explain.
- In one page explain what you think is the main 'message' of the Capital Asset Pricing Model to corporations and what is the main message of the CAPM to investors?
The Case report should be a two-page report. Please show your work for quantitative questions.source..
Finance Mod 3 Case
Date of Submission:
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) Ã— Beta (Vollmer, 2014).
Expected return = 4% +(12%-4%)*1.2
Expected return =14%
From the formula above, we can derive the Risk free rate as shown below
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