Assignment: 1. For each of the scenarios below, explain whether or not it repres

Question

Assignment:

1. 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

a. There's a substantial unexpected increase in inflation.

b. There's a major recession in the U.S.

c. A major lawsuit is filed against one large publicly traded corporation.

2. Use the CAPM to answer the following questions:

a. 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.   

b. 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.

c. What do you think the Beta (?) of your portfolio would be if you owned half of all the stocks traded on the major exchanges?  Explain.

3. 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.

Grading Rubric: Click here.

Explanation / Answer

1a undiversifiable (affects the whole economic environment)

b undiversifiable

c diversifiable (specific to a company or industry).

2. R= Rf +b(Rm-Rf)

12= 4+ 1.2 (Rm-4)

Rm= 10.67

9= Rf +0.8( 10-Rf)

Rf= 5

c) This would depend on whether the half you owned were risky (beta >1), non risky (beta<1), or average (beta=1).

3. CAPM for investors says what kind of return they should expect if they invest in a given stock or bundle of stocks. For corporations if indicates the rate of return they need to get on new projects to be able to raise the money to fund them and add value to the firm (raise their stock price).

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