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Corporate Finance Exercise: Correlation and Beta - CAPM

You have been provided the following data about the securities of tree firms, the market portfolio, and risk-free:

Security Expected return Standard deviation Correlation* Beta
Firm A .10 .27 (i) .85
Firm B .14 (ii) .50 1.50
Firm C .17 .70 .35 (iii)
The market portfolio .12 .20 (iv) (v)
The risk-free asset .05 (vi) (vii) (viii)

*With the market portfolio

a) Fill in the missing values in the table. (show workings)

b) Is the stock of Firm A correctly priced according to the capital asset pricing model (CAPM)? What about the stock of Firm B? Firm C? If these securities are not correctly priced, what is your investment recommendation for someone with a well-diversified portfolio?

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(iv) = 1 and (v) = 1. By definition, the correlation of anything with itself is 1, and the market has a beta 1.

(vi) = (vii) = (viii) = 0. The risk free has no risk (hence no std. dev.) and is not correlated with any other assets, including the market.

Next, we recall two forumlae,

Corr(X,Y) = Cov(X,Y)/[std(X)std(Y)], where std denotes the standard deviation and Cov denotes the ...

Solution Summary

Corporate finance: Correlation and Beta - Capital Asset Pricing Model

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After reviewing the McBride Financial Services scenario, you will identify several issues that directly connect to the concepts in the mind maps for Weeks 1 through 3. In addition to reading the assigned text materials to develop knowledge about the concepts, a thorough master's-level education requires the development of effective research skills. In this assignment, you will work collaboratively to create a rich source from which you will individually develop alternative solutions for McBride Financial Services.
Step 1
Individually, identify and research two companies that have faced specific issues related to those you identified in the scenario and connected with the course concepts. For each company selected, discuss the following in a 350-word synopsis: (A) issue identified in the scenario that is also facing the company, (B) how the company responded to the issue, and (C) outcomes of the company's response to the issue. Thus, each team member should have two 350-word synopses, one for each company, which provides the information identified. To avoid duplication of efforts, each team member should identify, to the team, the companies he or she will be researching before doing this part of the assignment.
Step 2
As a team, based upon the information gathered from the individual work done in Step 1, prepare a 1,050-word to 1,400-word analysis that synthesizes the key findings. As a team, using the companies researched: (A) identify the key course concepts and (B) compare and contrast the practices of each company related to those concepts. Appropriately cite all references used.
Step 3
The team will submit a final composition which consists of a title page, the team's overall analysis, the individual company synopses (with the preparer of each synopsis identified), and an appropriate reference page. As a guideline, a team of five will submit roughly 13-14 pages of material as well as a title page and reference page.

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