Financial Analysis

Financial Analysis

Part I

Answer # 1

Diversifiable risk that is also known to be unsystematic risk shows the portion of an asset's risk that is related to random causes which can be removed through diversification. It's relates to firm-oriented events, such as lawsuits, strikes, regulatory actions, and set back of a key account. This type of risk is related to factors that are limited to an industry or corporation like labor unions, product category, pricing, research and development, and marketing strategy.

On the other hand, systematic or non-diversifiable risk is the related portion of an asset's risk related to market factors such as inflation, international incidents, war, and political events. This type of risk cannot be removed through diversification. It is largely due to risk factors that influence overall market such as change in taxation clauses, investment policy changes, foreign investment policy and economic parameters. This type of risk is uncontrollable by investors and unable to be mitigated to a larger extent.

Classification of some the cases as diversifiable and non-diversifiable on the basis of its risk controllable and diversifiable through portfolio are as follows:

There's a substantial unexpected increase in inflation.

This scenario relates to non-diversifiable risks as it is related to market factors which are beyond human control and it cannot be eliminated through diversification. Unexpected inflation is non-diversifiable as it is sudden effect which can be removed immediately through diversification by an investor as it will affect an entire economy and all the companies.

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

This scenario also relates to non-diversifiable risks as it is related to market factors which are beyond human control and it cannot be eliminated through diversification. Major Recession is unexpected event which is not in control of investor and it effect cannot be mitigate by him.

A major lawsuit is filed against one large publicly traded corporation

This scenario relates to diversifiable risks as it is related to random causes which can be eliminated through diversification. An investor can invest in several corporations in order to eliminate its risk. It is considered to be diversifiable as investor can increase its portfolio while investing in several companies.

Answer # 2

Expected Rate of Return on the Market Portfolio

ri = 0.12

rf = 0.04

b = 1.2

According to CAPM Approach:

ri = rf + (rm - rf ) (b)

0.12 = 0.04 + (rm - 0.04) (1.2)

0.12 - 0.04 = (rm - 0.04) (1.2)

rm = (0.08 / 1.2) + 0.04

rm = 0.106 = 10.6 %

Thus, its expected rate of return on the market portfolio is 10.6%

Risk-Free Rate

rj = 0.09

rm = 0.10

b = 0.8

According to CAPM Approach:

ri = rf + (rm - rf ) (b)

0.09 = rf + (0.10 - rf) (1.2)

0.09 = rf + 0.12 - 1.2 rf

1.2 rf - rf = 0.12 - 0.09

0.2 rf = 0.03

rf = 0.15 = 15%

Thus, its risk-free rate is 10.6%

Beta (ß) of your portfolio would be if you owned half of all the stocks traded on the major exchanges

If you owned half of all the stocks traded on the major ...