Expert answer:Systematic Risk and CAPM
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Assignment-4
Systematic Risk and CAPM (85 points)
Purpose of this project is to calculate the systematic risk (β) of your company, and therefore to estimate
the required rate of return (k) using CAPM.
A. The calculation should rely on at least 60 monthly (or 250 weekly) returns on your company’s stock
and on the market (S&P 500 Index, for example). A regression line should be built on Excel and a graph
of the characteristic line (SCL) should be provided. A short interpretation on β value and characteristic
line should be given too.
B. You should build your own security market line (SML). Explain your calculation for the annual risk
free rate and the annual market return. The required return (k) should be visible on the graph and
its value should be supported by calculation.
Do not forget to provide in appendices:
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•
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The table showing prices and returns you use to calculate β and to build the characteristic line
A graph showing characteristic line and β
A graph showing the SML, the risk free rate, the market return, and your company required
return k.
Problem Solving Assignment (15 points)
1.
(15 points) Suppose the yield on short-term government securities (perceived to be risk-free) is
about 4%. Suppose also that the expected return required by the market for a portfolio with a
beta of 1 is 12%. According to the capital asset pricing model:
a. What is the expected return on the market portfolio?
b. What would be the expected return on a zero-beta stock?
c. Suppose you consider buying a share of stock at a price of $40. The stock is expected to pay a
dividend of $3 next year and to sell then for $41. The stock risk has been evaluated at beta =-.5.
Is the stock overpriced or underpriced? What is its alpha?
…
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