CAPM AND SOURCES

CAPM and Sources for Capital Module 3

CAPM and Sources for Capital Module

Systematic risk or risk of non-diversification

The Non-diversified risk provides the capital asset pricing model framework for analyzing the relationship between return and risk on all types of assets. The overall risk model is used, but only part of the so-called systematic risk. Is that part of the risk of a security caused by the elements affect the market as a whole, and therefore cannot be eliminated through diversification because it affects almost all companies in the same time. Among these elements there is inflation, interest rates, fiscal and monetary policies. Result in a rise in interest rates, for example, to a decline in bond prices. 

The risk of irregular or risk potentially diversify

Is that part of the risk of a security caused by the elements of a private company, and thus can reduce the unit through diversification because any negative effects on the Company may offset optimistic effects on other company. Among the elements of risk are not organized, there is a strike by the workers and poor management of the company and high level of debt (Bernstein, 2005).

Capital asset pricing model

Reflects the capital asset pricing model for the relationship between return and risk using beta as a measure of risk. In this model is determined by the required rate of return on the investment risk by adding a risk premium to the rate of return risk-free.

Capital asset pricing model:

Where:

: The required rate of return on the stock 

: Rate of return risk-free

: Beta of the shares 

: Rate of return on the market portfolio

: Risk premium, i.e. the required rate of return in addition to the rate of return risk-free

: In addition to market risk

There's a substantial unexpected increase in inflation

The substantial unexpected increase in the inflation is un-diversifiable risk, as inflation is caused due to growth of economy, and sometime it is occurs due to drop down in the economy. The risk of inflation cannot be diversified as meantime this is the unavoidable risk as well (Breeden, 1979).

There's a significant recession in the U.S

In general this can be said that the recession is the diversified risk as this can be avoided by taking some significant steps to control the prices. The recession can be avoided by making adjustments in the fiscal and monetary policies of the economy. In the context of the United States the recession can be avoided, by cutting their expenditures.

A significant lawsuit is filed against one large publicly traded corporation

The filling of lawsuit against the large corporation, is the avoidable and diversifiable, because this is the sort of situation are traditionally faced by such large corporations. The competitors, of such large firms try to defame the large corporations, and this is publically known that this has been tactic of independent competitors to defame the corporation`s worth.

Calculate the Expected Rate of Return on the Market Portfolio

K0 =Rf + ß * (Km - Rf)

K0 =0.121.20.10-0.04

K0 =0.12 + (0.072)

k0=0.192

Find the Risk-Free Rate

K0 =Rf + ß * (Km - ...