Ch 09 revised

Ch 09 revised - CHAPTER 9 THE CAPITAL ASSET PRICING MODEL 1...

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CHAPTER 9: THE CAPITAL ASSET PRICING MODEL 1. E(r P ) = r f + β P [E(r M ) – r f ] 18 = 6 + β P (14 – 6) β P = 12/8 = 1.5 2. If the security’s correlation coefficient with the market portfolio doubles (with all other variables such as variances unchanged), then beta, and therefore the risk premium, will also double. The current risk premium is: 14 – 6 = 8% The new risk premium would be 16%, and the new discount rate for the security would be: 16 + 6 = 22% If the stock pays a constant perpetual dividend, then we know from the original data that the dividend (D) must satisfy the equation for the present value of a perpetuity: Price = Dividend/Discount rate 50 = D/0.14 D = 50 × 0.14 = $7.00 At the new discount rate of 22%, the stock would be worth: $7/0.22 = $31.82 The increase in stock risk has lowered its value by 36.36%. 4. a. False. β = 0 implies E(r) = r f , not zero. b. False. Investors require a risk premium only for bearing systematic (undiversifiable or market) risk. Total volatility includes diversifiable risk. c. False. Your portfolio should be invested 75% in the market portfolio and 25% in T-bills. Then: β P = (0.75 × 1) + (0.25 × 0) = 0.75 6.
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This note was uploaded on 11/02/2011 for the course FIN 300 taught by Professor Staff during the Summer '08 term at Ill. Chicago.

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Ch 09 revised - CHAPTER 9 THE CAPITAL ASSET PRICING MODEL 1...

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