ou are analyzing a regression of DePaolo Foods, a manufacturer of spaghetti and olive oil, against the S&P 500, using monthly returns over 5 years. Return( DePaolo Foods) = -0.002 + 1.3 Returns(S&P 500) R2 = 0.35 Assume that you have been asked to be market neutral (assume that the market is correctly priced today). You have computed a historical risk premium of 0.05 by looking at returns on stocks and bonds from 1928 to 2001 and an implied equity premium of 0.034 based upon the S&P 500 today. If the current treasury bill rate is 0.024,the treasury bond rate is 0.049 . Estimate the cost of equity for this firm using the implied equity risk premium. What proportion of firm's risk is diversifiable?
Risk and return
Before understanding the concept of Risk and Return in Financial Management, understanding the two-concept Risk and return individually is necessary.
Capital Asset Pricing Model
Capital asset pricing model, also known as CAPM, shows the relationship between the expected return of the investment and the market at risk. This concept is basically used particularly in the case of stocks or shares. It is also used across finance for pricing assets that have higher risk identity and for evaluating the expected returns for the assets given the risk of those assets and also the cost of capital.
You are analyzing a regression of DePaolo Foods, a manufacturer of spaghetti and olive oil, against the S&P 500, using monthly returns over 5 years.
Return( DePaolo Foods) = -0.002 + 1.3 Returns(S&P 500) R2 = 0.35
Assume that you have been asked to be market neutral (assume that the market is correctly priced today). You have computed a historical risk premium of 0.05 by looking at returns on stocks and bonds from 1928 to 2001 and an implied equity premium of 0.034 based upon the S&P 500 today. If the current treasury bill rate is 0.024,the treasury bond rate is 0.049 .
Estimate the
What proportion of firm's risk is diversifiable?
Trending now
This is a popular solution!
Step by step
Solved in 2 steps
