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# CAPM: Finance Mod 3 Case (Essay Sample)

Instructions:

- 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?

**Assignment Expectations**

The Case report should be a two-page report. Please show your work for quantitative questions.

source..Content:

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) Ã— 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

E...

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