Explain the CAPM model. Choose two firms from that list and discuss whether the betas are...

Explain the CAPM model. Choose two firms from that list and discuss whether the betas are what you would expect. Be sure to explain why or why not. Calculate the returns based on the CAPM model. Be sure to state your assumptions.

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Expert Solution

Capital Asset Pricing Model (CAPM) is used for calculating the expected return of a risky asset.

R = Rf + B * (Rm - Rf)

Where, R = expected return of the risky asset

Rf = risk free rate

B = Beta (systematic risk)

Rm = expected market return

Rm - Rf is also called the equity risk premium.

Firm 1: Apple Inc.

Rf = 2.98% (US 10 year Bond yield)

Beta = 1.14

Equity Risk premium = Rm - Rf = 5.08%(From Aswath Damodaran's website)

Therefore, expected return = 2.98 + 1.14 * 5.08 = 8.77%

Firm 2: Amazon.com, Inc.

Rf = 2.98% (US 10 year Bond yield)

Beta = 1.14

Equity Risk premium = Rm - Rf = 5.08%(From Aswath Damodaran's website)

Therefore, expected return = 2.98 + 1.72 * 5.08 = 11.72%

Assumptions:

1. There are no taxes.

2. There are no transaction costs.

3. Investors are fully rational and risk-verse.

4. Markets are efficient. Nobondy has any material insider information.

5. All investors are price-takers,i.e. they cannot influence the price of a stock.

jeff jeffy answered 1 year ago

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