Large Fire Damages Three Major Research Proposal

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5Rf .5Rf = 4

Rf = 8

c) If I owned half of the stocks on all the major stock exchanges, the beta of the portfolio would be 1. The portfolio should be expected to be perfected diversified with such a high amount of holdings. A perfectly diversified portfolio would trade in line with the market, and would therefore have a beta of 1.

3. The main message of CAPM to corporations is that the payoff of each investment they make should be made with risk level in mind. Executives are faced with a wide range of investment possibilities every day. The expected payoff of each of these activities, however, is subject to certain risk factors. A careful analysis of these risk factors must be carefully considered in order to understand the value of the investment relative to the risk that is being undertaken. It is not simply the expected return of a capital asset that must be considered.

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The risk level of that asset is an integral component of the decision-making process. Riskier investments may offer better returns, but may not fit with the corporate profile, culture or objectives. CAPM attunes executives to the risk side of the risk-return equation, so that their decisions are more carefully considered.

For investors, CAPM highlights the value of diversification. Betas -- indicating risk level -- are published for all publicly traded firms. These betas illustrate the risk associated with the stock of that company. The beta of a portfolio is the weighted average of the betas of the stocks in the portfolio. A perfectly diversified portfolio will therefore trend towards a beta of 1 -- the market beta.

CAPM therefore highlights the importance of weighing the portfolio's returns against the portfolio's risk. The objective in portfolio management is to….....

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