Question

Asset Pricing (CAPM & APT) 

1 If you want to invest into a stock A for one year, and given that during this period the expected return of the S&P 500 index is 25%, the risk-free rate in the market is 5% and stock A's sensitivity to the market risk is 0.5 

Compute the expected return of stock A that you want to invest. 

Introduction to Corporate Finance 

2 From the shareholders' view, what is the goal of financial management?

Answer 1

QUESTION 1

AS PER THE CAPITAL ASSET PRICING MODEL,

EXPECTED RETURN (R_a) = RISK FREE RETURN + MARKET PREMIUM * BETA

• WHERE, MARKET PREMIUM = MARKET RETURN - RISK FREE RETURN

IN YOUR PRESENT CASE,

EXPECTED RETURN ON STOCK A = 5% + ( 25% - 5%)0.5

= 15%

QUESTION 2

THE TWO WIDELY DISCUSSED GOALS OF FINANCIAL MANAGEMENT ARE

• PROFIT MAXIMISATION
• WEALTH MAXIMISATION

THE RELEVANT GOAL FROM THE SHAREHOLDER VIEW IS WEALTH MAXIMIZATION.

IT MEANS THE MAXIMISATION OF THE NET PRESENT VALUE OF THEIR INVESTMENT. NET PRESENT VALE IS THE DIFFERENCE BETWEEN THE PRESENT VALUE OF IT FUTURE EXPECTED CASH FLOWS AND ITS COST. THE CASH FLOWS ARE DISCOUNTED AT A RATE WHICH REFLECTS BOTH TIME AND UNCERTAINTY. WE ASSUME THAT THE OBJECTIVE MAXIMISATION OF THE VALUE OF FIRM WHICH REFLECTED BY TH MARKET PRICE OF THE HARE OR STOCK.THE VALUE OF SHARE IN THE SHARE MARKET AT AFFECTED BY MANY REASON LIKE DIVIDEND POLICY, RISKY INVESTMENT BY THE COMPANY, GOOD SALES ETC. IT ALL DEPENDS UPON THE CONFIDENCE OF THE INVESTOR ON THE COMPANY.

IT IS BETTER BEST OBJECTIVE BECAUSE-

1. MEASURE BENEFITS IN TERM OF CASH FLOWS AVOIDING AMBIGUITY ASSOCIATED WITH ACCOUNTING PROFIT.
2. CONSIDER THE CONCEPT O TIME VALUE AND MONEY
3. DISCOUNTS FUTURE CASH FLOW BY COST OF CAPITAL CONSIDERING RISK AND UNCERTAINTY\
4. LONG TERM OBJECTIVE AND BROADER THAN PROFIT MAXISATION.