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Capital Asset Pricing Model

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Capital Asset Pricing Model
James D. Lowe
Trident University International
FIN301 - Principles of Finance
Module 3
Case Assignment

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 (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?
1. For each of the scenarios below, explain whether or not it represents a diversifiable or an un-diversifiable risk. Please consider the issues from the viewpoint of investors. Explain your reasoning

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

Un-diversifiable risk
The entire economy will be affected by a substantial unexpected increase in inflation. In fact is inflation hits us all and being that it is “substantial” tells me either we are heading towards a national recession or into another “war” scenario.

b. There's a major recession in the U.S.
Diversifiable risk
I know I stated that substantial inflation is a Un-diversifiable risk, but I believe a major recession could be a diversifiable risk if proper planning

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