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Economics abdi

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ECONOMICS 1
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Economics
Author’s name
Professor’s name
Course
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ECONOMICS 2
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Economics
Question 1 [100 marks in total]
A. Consider the following graph:
1) Explain the link between the CAPM model and the SML.
The capital asset pricing model generally defines the relationship between expected
return and systematic risk for assets, mainly stocks (Ahuja, Dawar & Arrawatia, 2016). This
particular model is extensively utilized throughout price financing for risky security as well as
the generation of expected returns for assets given the cost of capital and the risk of the assets.
The link between the CAPM model and the security market line is that it is a graphical
representation of capital asset pricing model and therefore is inclined to plot the risks
A (𝑅 = 11%, β = 0.5)
C (𝑅 = 20%, β = 1.2)
B (𝑅 = 12%, β = 1.0)
R
i
Beta
𝛃
𝒎
= 1.0
R
f
= 5%
Return on Investment
SML

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ECONOMICS 1 Economics Author’s name Professor’s name Course Date Continued on next page… Page 1 of 7 ECONOMICS 2 Economics Question 1 [100 marks in total] A. Consider the following graph: Ri Return on Investment C (𝑅 = 20%, β = 1.2) SML 15 % A (𝑅 = 11%, β = 0.5) B (𝑅 = 12%, β = 1.0) Rf = 5% 𝛃𝒎 = 1.0 Beta 1) Explain the link between the CAPM model and the SML. The capital asset pricing model generally defines the relationship between expected return and systematic risk for assets, mainly stocks (Ahuja, Dawar & Arrawatia, 2016). This particular model is extensively utilized throughout price financing for risky security as well as the generation of expected returns for assets given the cost of capital and the risk of the assets. The link between the CAPM model and the security market line is that it is a graphical representation of capital asset pricing model and therefore is inclined to plot the risks Continued on next page… Page 2 of 7 ECONOMICS 3 comparative to the anticipated results. Both are also widely utilized in comparison as well as equity valuation since they are not standalone tools (Ahuja, Dawar & Arrawatia, 2016). [5 marks] 2) Based on the CAPM, is security C (point C) over- or undervalued? Based on the capital asset pricing, security C is undervalued. This is because the spot on the chart points out that the security is inclined to offer a greater return contrary to its integral risk (Ahuja, Dawar & Arrawatia, 2 ...
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