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Investment Analysis using the CAPM and SML.

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QUESTION 1:
The capital asset pricing model (CAPM) contends that there is systematic and unsystematic risk for an individual security. Which is the relevant risk variable and why is it relevant? Why is the other risk variable not relevant?

QUESTION 2:
a. You expect an RFR of 10 percent and the market return (RM) of 14 percent. Compute the expected return for the following stocks, and plot them on an SML graph.

Stock Beta E ( Ri )
U 0.85
N 1.25
D -0.20

b. You ask a stockbroker what the firm's research department expects for these three stocks. The broker responds with the following information:

Stock Current Price Expected Price Expected Dividend
U 22 24 0.75
N 48 51 2.00
D 37 40 1.25

Plot your estimated returns on the graph from Part a, and indicate what actions you would take with regard to these stocks. Explain your decisions.

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Solution Summary

The attached word document provides detailed explanations to the attached questions.

The Capital asset Pricing model is fully described and explained. Returns, under SML, are calculated.

All formulas and calculations are provided.

Further readings materials are also provided.

Thank you.

Solution Preview

The attached Microsoft Word® document contains detailed explanations ...

Solution provided by:
Chidi Ngene, M. Sc.
Education
  • B. Sc., University of Nigeria
  • M. Sc., London South Bank University
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