Question

Question 4

(a) Describe the Capital Asset Pricing Model (CAPM).

(4 marks, maximum 200 words)

(b) Using the CAPM derive the required annual rate of return on the market portfolio given the following information:

• The current rate of return on treasury bills is 3.5%.

• The required annual rate of return on a security with a beta of 1.5 is 12.2%.

(2 marks)

(c) Distinguish between

i. Systematic, and

ii. Unsystematic risk

(4 marks, maximum 200 words)

Total for the question 10 marks

Answer 1

A

The Capital Asset Pricing Model (CAPM) portrays the connection between systematic risk and expected return for assets, especially stocks. CAPM is broadly utilized all through money for pricing risky protections and producing expected returns for assets given the risk of those assets and cost of capital. Financial specialists hope to be made up for risk and the time estimation of cash. The sans risk rate in the CAPM equation represents the time estimation of cash. Different segments of the CAPM equation represent the speculator taking on extra risk.

The beta of a potential speculation is a proportion of how much risk the venture will add to a portfolio that resembles the market. In the event that a stock is riskier than the market, it will have a beta more prominent than one. On the off chance that a stock has a beta of short of what one, the equation accept it will diminish the risk of a portfolio.

B. The current rate of return on treasury bills is 3.5%.

• The required annual rate of return on a security with a beta of 1.5 is 12.2%.

CAPM Formula (Expected return) = Risk free return (3.5%) + Beta (1.5) * Market risk premium (12.2 % - 3.5%)

= 3.5 + 1.5(8.7)

= 3.5 + 13.05

= 16.55

Expected Rate of Return = 16.55

C

The systematic risk is a consequence of outside and wild factors, which are not industry or security explicit and influences the whole market prompting the variance in costs of the considerable number of protections. Then again, unsystematic risk alludes to the risk which rises out of controlled and known factors, that are industry or security explicit.

Systematic risk can't be dispensed with by broadening of portfolio, though the expansion demonstrates supportive in dodging unsystematic risk.