RISK AND RETURN CUSTOM ESSAY


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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. A large fire severely damages three major U.S. cities. b. A substantial unexpected rise in the price of oil. 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 10%, the Risk-Free Rate is 3%, and the Beta (b) for Asset “i” is 1.5. b. Find the Risk-Free Rate given that the Expected Rate of Return on Asset “j” is 14%, the Expected Return on the Market Portfolio is 12%, and the Beta (b) for Asset “j” is 1.5. c. 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. 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. Required Readings: I personally recommend reading up on the basic concepts behind the Capital Asset Pricing Model first before worrying about the formula. But still many of you are eager to learn the formulas first, so here are a few links below. But don’t fixate on the formulas, spend an equal if not greater amount of time reading up on the basic concepts: Investopedia (n.d.). Capital Asset Pricing Model, retrieved August 2008 from: http://www.investopedia.com/terms/c/capm.asp MoneyChimp, (n.d.) CAPM calculator, retrieved August 2008 from:http://www.moneychimp.com/articles/valuation/capm.htm Value Based Management, (n.d.) Capital Asset Pricing Model, retrieved August 2008 from: http://www.valuebasedmanagement.net/methods_capm.html To gain a deeper understaning of the CAPM and associated concepts beyond just the formula, read: Damodaran, A. (n.d). Picking the right projects: Investment analysis. Retrieved August 2, 2007 from: http://pages.stern.nyu.edu/~adamodar/pdfiles/cfovhds/inv.pdf Risk and Return (1991). The Economist, 318, 72-73 This Article on Investment Analysis is a highly comprehensive overview on measuring risk and the use of the CAPM. This article is a good place to start because it will give you an idea of how the CAPM is used in the “real world” as well as demonstrate the basic concepts of this Module. Teach Me Finance has a good Page on the CAPM as well as a page on the Security Market Line. These are some brief but informative tutorials on these important topics.

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