Various risk and return models is used to compute the cost of equity but they all...

Various risk and return models is used to compute the cost of equity but they all assume that the marginal investor is well diversified. If you use these models to estimate cost of equity for private or closely held firms, you are likely to under or over estimate the cost of equity. How would you fix the bias?

Expert Solution

Various models which are used to determine the cost of equity already assumes that investor has properly diversified portfolio and he is completely hedged against any kind of unsystematic risk so his portfolio has been completely diversified and his unsystematic risk is completely eliminated out of portfolio and he is only exposed to the systematic risk and the market risk which can never be diversified so these models are often trying to to calculate the cost of equity based upon systematic risk like Capital Asset pricing model.

I will be trying to ascertain the risk of investment into a security through unsystematic risk factors and I will be trying to ascertain the overall risk in the portfolio by standard deviation as the standard deviation is not only just accounting for systematic this but it is also accounting for the micro risk factor and I will also try to find out the the particular and a specific analysis approach in order to determine the risk related to investment into a security because various securities have a specified risk and those are reflected through unsystematic risk and these risk are to be accounted into the process of investing because in the real life every investor is not well diversified and he is exposed to the firm specific risk, so I will be trying to ascertain the risk of the firm by individual analysis and I will be trying to find the unsystematic risk of the portfolio and I will be trying to factor in the standard deviation as well because standard deviation will be a calculation of the overall risk of the portfolio and it is not only accounting for the systematic response and so we can get over the models like Capital Asset pricing model and arbitrage pricing theory and we will be trying to enhance upon them by inclusion of the unsystematic risk factors.

jeff jeffy answered 2 years ago

Cost of equity is estimated by two models. How is risk explicitly and implicitly incorporated in...

Cost of equity is estimated by two models. How is risk explicitly and implicitly incorporated in each of the two models? Stock prices fell drastically in March after the pandemic spread and the economy came to a grinding halt. Explain this phenomenon. Why have the stock prices gone up significantly during the month of May and June ? Please answer the question in detail using finance terminology

Cost of Common Equity: Cost of Retained Earnings, rs: Suppose that (1) the risk-free return is...

Cost of Common Equity: Cost of Retained Earnings, rs: Suppose that (1) the risk-free return is 5.5%; (2) the average stock return (i.e. the market return) is 11.5%; (3) your firm stock’s beta (i.e. stock’s risk) is 0.8; (4) the next dividend payment will be $1; (4) the growth rate of the dividend is 6%; (5) the current market price of the stock is $25; (6) the yield of your firm’s long-term bond is 6.5%; and (7) the risk premium...

What model is used to compute the value of the equity?

Compute the Compute the Expected Return and Standard Deviation (risk) of the the portfolio below: Economy...

Compute the Compute the Expected Return and Standard Deviation (risk) of the the portfolio below: Economy Chances Stock A Stock B Stock C Weight 30% 40% 30% Boom 15% 30% 45% 33% Normal 50% 1% -15% -5% Poor 35% -20% -30% -9% E( R ) = Risk =

Compute the cost of debt financing. Compute the cost of equity financing using the capital asset...

Compute the cost of debt financing. Compute the cost of equity financing using the capital asset pricing model. Compute the weighted average cost of capital. The capital investment is to be depreciated as a 7 year asset using this table: Ownership year 1 (14.29%), year 2 (24.49%), year 3 (17.49%), year 4 (12.49%), year 5 (8.93%), year 6 (8.92%), year 7 (4.46%). Evaluate each independent project by computing net present value, internal rate of return, and payback. Then decide whether...

There are different risk management models used by different businesses. One of these models contains seven...

There are different risk management models used by different businesses. One of these models contains seven key steps. Discuss the first THREE of these steps; providing an example of how each would work in practice.........

Why is the return on equity greater than the return on assets if the cost of...

Why is the return on equity greater than the return on assets if the cost of debt is less than the ROA? Why is the ROE less than the ROA if the cost of debt is greater than the ROA? Why does the ROE equal the ROA if the cost of debt is equal to the ROA?

Financial risk management models are only as good as the data that are used in the...

Financial risk management models are only as good as the data that are used in the models. Identify three potential problems with data used in the models and how these problems could be mitigated.

1- Briefly describe the three models used to compute the price of a common stock. 2-...

1- Briefly describe the three models used to compute the price of a common stock. 2- Briefly explain the theory of rational expectations and the adaptive expectations. 3- Why the efficient market hypothesis does not imply that financial markets are efficient? 4- How valuable are published reports by investment advisors? 5- What is a financial crisis? Also, briefly explain the sequence of events in financial crisis in advanced economies. 6- Briefly explain the global financial crisis of 2007-2009. 7- What...

Compare and contrast the risk and the return for debt and equity securities from the pespective...

Compare and contrast the risk and the return for debt and equity securities from the pespective of lenders/investors and issuers Do not want to copy the answer directly from the Google. hope to be able to express clearly with own words. Thanks！

Question