In Chapter 8, Mayo (2019) discussed the relationship between risk and required return and referenced the...

In Chapter 8, Mayo (2019) discussed the relationship between risk and required return and referenced the capital asset pricing model (CAPM) as a method for investors to value an asset’s expected return. Write a short essay (300 words or less) to explain the CAPM concept and discuss the interrelationship of its three components in accounting for systematic and unsystematic risk. You may supplement your answer using outside sources. Please no cursive pictures.

Solutions

Expert Solution

Capital Asset pricing model is a model in order to find out the expected rate of return which is associated with it and it will be providing a with risk free rate along with beta of the assets which will be representative of the systematic risk associated with asset and we will also be considering risk premium which will be representative of the difference between the risk free rate and the market rate of return.

Capital Asset pricing model is having an unique element of identification of the risk by determination of the beta associated with the portfolio because beta will be reflective of the systematic risk or market risk which can never be managed while Capital Asset pricing model will be arguing that the unsystematic risk associated with the portfolio is already managed and the portfolio is well diversified in advance so it can be said that it is only considering systematic risk in order to find out the required rate of return which an investor will be demanding in order to compensate for the risk undertaking by purchasing an asset so he will be trying to ascertain his overall expected rate of return in relation to to risk free rate and market rate of return.

it will be assumed that unsystematic risk is completely eliminated in the portfolio and only systematic risk will be existent in the portfolio which will help in finding out the expected rate of return.

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

The Security Market Line (SML) provides the relationship between risk and required rate of return. Which...

The Security Market Line (SML) provides the relationship between risk and required rate of return. Which of the following statements about the SML is most correct? A The relevant risk is portfolio risk, which is measured by beta. B The relevant risk is total risk, which is measured by standard deviation. C The relevant risk is mutual risk, which is measured by coefficient of variation. D The SML is an equation, but it cannot be graphed. E The SML is...

Explain the relationship between risk, the expected rate of return and the actual rate of return.

Assume that the risk-free rate is 4.5% and the required return on the market is 8%....

Assume that the risk-free rate is 4.5% and the required return on the market is 8%. What is the required rate of return on a stock with a beta of 2? Round your answer to two decimal places.

1-What is the basic relationship between risk and return and howis this reflected in the...

1-What is the basic relationship between risk and return and how is this reflected in the value of the firm’s stock? The cost of debt?2-What are the primary factors that should be considered when establishing a firm’s capital structure?3-What are the primary differences and/or similarities between financial risk and business risk?

The relationship between risk and return is an important concept as it has numerous implications for...

The relationship between risk and return is an important concept as it has numerous implications for both corporate managers and investors. Corporate managers assess the risk and return of new projects or investments. Investors assess the risk and return of financial assets before making investment decisions. Discussion Questions: Explain the risk and return trade-off. Describe the differences between systematic risk and unsystematic risk. Provide examples of systematic risk and unsystematic risk. How both risks are measured? Which risk is more...

3. The risk-free rate is 2%, and the required return on the market is 8%. What...

3. The risk-free rate is 2%, and the required return on the market is 8%. What is the required return on an asset with a beta of 1.2? What is the reward/risk ratio? What is the required return on a portfolio consisting of 80% of the asset with a beta of 1.2 and the rest in an asset with an average amount of systematic risk? 4. Using the CAPM, show that the ratio of the risk premiums on the two...

Statement 1: The actual relationship between the risk-free rate of return ( r* ) and the...

Statement 1: The actual relationship between the risk-free rate of return ( r* ) and the expected future inflation rate or inflation premium (IP) is actually multiplicative—that is, [(1 + rRF ) x (1 + IP)] – 1—but it is often simplified to reflect an additive relationship. Statement 2: All else being equal, the more highly that savers and investors prefer immediate spending to deferred consumption, the lower the compensation that savers and investor will require to induce them to...

1) What is the relationship between the market risk of a stock and its expected return?...

1) What is the relationship between the market risk of a stock and its expected return? 2) What is the CAPM? What does it tell you? 3) What is the difference between beta and standard deviation?

The relationship between investment risk and potential return is positive. Analyze the risks of investment and...

The relationship between investment risk and potential return is positive. Analyze the risks of investment and the returns from investment.

4. How do you define and measure financial risk? Discuss the relationship between risk and return...

4. How do you define and measure financial risk? Discuss the relationship between risk and return when it comes to building an investment portfolio. Provide examples of how you would modify a portfolio to best fit an investor’s individual risk profile.

Subjects