THE CAPITAL ASSET PRICING MODEL

Assignment Overview

I. 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.

1. There's a substantial unexpected increase in inflation.
2. There's a major recession in the U.S.
3. A major lawsuit is filed against one large publicly traded corporation.

II. Use the CAPM to answer the following questions:

1. 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.

2. 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.

3. 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.

III. 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.