Capm

PART I:

1.

a. When there is a substantial unexpected increase in inflation it is an undiversifiable risk. This is because as a company’s revenue should increase at about the same rate as inflation, but it can reduce confidence for long term investments. Since this doesn’t impact only this security it is an undiversifiable risk.

b. With a major recession and its impact on all sectors of the economy, the economy will experience slow growths all around. Investors will be forced to adjust their operation costs regardless of their investments. This means that when there is a major recession it is an undiversifiable risk. Since this doesn’t impact only this security it is an undiversifiable risk.

c. The lawsuit against one large publicly traded corporation has nothing to do with other corporation bodies. As such the case will only impact the investors of the corporation directly and other investors can still invest in other publicly traded corporations. Since this does impact only this security and not others, it means that a lawsuit against a publicly traded company is a diversifiable risk.

2.

CAPM: E = R+B(M-R)

E = Expected Rate of Return

R = Risk Free Rate

B = Beta of the Security

M = Expected Market Return

a. X = 4 + 1.2 (12 – 4)

X = 4 + 1.2 (8)

X = 4 + 9.6

X = 13.6 %

b. 9 = X +.8 (10 -X ) Simplify the equation

9 = X + 8 - .8X Combine Xs first

9 = 8 + .2X

-8 -8

1 = .2X Divide by .2

____________

.2 .2

5 = X

Therefore the RFR equals 5%

c. Since the Beta is the measure of risk in investment, then the beta of a portfolio where you owned half the sticks on the major exchanges will be quite large on recessions and quite small during inflation periods of the share prices.

3.

a. CAPM sends the general message of Rate of Return for corporations. In this rate of return, the corporation would be able to know whether they have positive or negative growth. Corporations tend to understand business performance in various...