Unit_9_Part 2 PDF Slides 7ce (for printing)

9.2 Measuring Market Risk :

The beta of a stock measures the sensitivity of the stock’s returns to the

The correct answer is D.

The beta of a portfolio is the weighted average

Beta = 0.8Beta = 1.5 If a security’s return lies below the line, the investment should

estimate (given), the portfolio is expected to provide only a

would fall below the

The correct answer is C.

= 12% and R f=1%. Find R

You need know the difference between the market’s return

and the market risk premium(R m-R f).

free rate is 1% and the market return is 9%. Find the required rate of

This is the required return,

or cost of capital, for the

entire firm (not necessarily

any projects)

•Discount the project’s cash flows at the project’s cost of capital.

(This may or may not be the firm’s cost of capital)

•Project cost of capital is based on the project risk.

•High operating leverage increases project risk

• these Projects have high betas.

•The discount rate should only reflect the systematic risk of the

project. It should not be adjusted to offset potential errors or

biases in the cash flow forecasts.

Using your calculator, first solve for the IRR of the project:

cost of capital = required rate of return = 15%, and the

only generating a 12.6% return, the project is

enough return for its level of risk and would plot below the SML.

Studies have found the CAPM is too simple to capture exactly how