Question

DISCUSS THE CAPITAL ASSET PRICING MODEL, INCLUDING SYSTEMATIC RISK, BETA, THE RELATIONSHIP BETWEEN RISK AND RETURN, HOW TO AVOID RISK, AND THE RELATIONSHIP BETWEEN OF BETA TO STOCK PRICES

Answer #1

Capital Asset Pricing Model aka CAPM is the model which tries to quantify the risk and return relationship.

CAP Model has various components on which depends for calculations:

- Risk-Free Rate - Is the return an investor can earn even with assuming an only nominal level of risk. This can be seen as the base rate of return.
- Risk premium - Is the premium of return over risk-free rate which an investor tries to achieve which a given level of risk.
- Beta - It is the measure of stock's risk reflected - it denotes the unsystematic risk for the business.

The risk denoted by the Beta is a company-specific risk which shows a company's relative risk as to the market risk. This type of risk can be easily reduced by maintaining a good balance diversified portfolio by the investor.

a) Explain the concepts of variance (total risk) and beta
(systematic risk) in portfolio theory and the capital asset pricing
model. b) Discuss why according to the capital asset pricing model
that total risk should not be rewarded by the capital market. You
may use diagrams in your explanation if you wish.

Discuss how the capital asset pricing model CAPM rewards
shareholders for risk.

Capital Asset Pricing Model
Studies have found that Beta is not the only factor that matters
for determining the expected return on a stock a. Mention and
explain 3 other factors that impact the expected return of the
stock and how they could affect it.

The capital asset pricing model suggests that the required
return on a firm's stock is a positive function of:
unsystematic risk
the market rate of return
the competitor fs cost of equity
All of these are correct.

Which of the following is TRUE?
Select one:
a. The capital asset pricing model is used to calculate the effect
of increase in prices of capital assets due to inflation.
b. The capital asset pricing model describes the relationship
between the required return, or the cost of common stock equity
capital, and the nonsystematic risk of a firm as measured by the
beta coefficient.
c. The amount of preferred stock dividends that must be paid each
year may be stated...

Which of the following is TRUE?
Select one:
a. The capital asset pricing model is used to calculate the effect
of increase in prices of capital assets due to inflation.
b. The capital asset pricing model describes the relationship
between the required return, or the cost of common stock equity
capital, and the nonsystematic risk of a firm as measured by the
beta coefficient.
c. The amount of preferred stock dividends that must be paid each
year may be stated...

(Capital asset pricing model) The expected return for the general
market is 13.9%, and the risk premium in the market is 7.0%.
Tasaco, LBM, and Exxos have betas of 0.834, 0.649, and 0.522,
respectivily. What are the corresponding required rates of return
for the three securities?

Discuss how costs of capital relate to Capital Asset
Pricing Model (CAPM).

Use the Capital Asset Pricing Model to calculate the expected
return of two stocks (X and Y) with the following characteristics:
Beta for Stock X = 1.50: Beta for Stock Y = 0.75: Expected market
Return = 9%, and 10-Year Treasury Note Rate = 3%. (Must show work
to receive full credit)

Applying the capital-asset pricing model approach, compute the
required rate of return for each of the following stocks. Assume a
risk-free rate of 0.05 and an expected return for the market
portfolio of 0.15.
STOCK
A
B
C
D
BETA
2.0
1.0
-0.5
0
(a) If
you could only invest in one of these stocks, justify which stock
you would choose.
(b)
Suggest which type of stock does stock C belong to. Explain your
answer.

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