Unit 6 Assignment
Barbara Parker
GF530: Financial Statement Analysis
Professor Danyell Weaver
February 13, 2016
Unit 6 Assignment
Chapter 11
Question 11.2 THE COMPONENTS OF THE CAPM. The CAPM computes expected rates of
return using the following model (described in the chapter):
E[REj] = E[RF] + βj x {E[RM] – E[RF]}
Explain the role of each of the three components of this model.
E[RF] is the expected rate of return an investor can expect on a risk-free investment (Wahlen,
Baginski, & Bradshaw, 2011). βj is the market beta for firm j (Wahlen et al., 2011). {E[RM] –
E[RF]} represents the market premium (Wahlen et al., 2011).
Question 11.3 NONDIVERSIFIABLE AND DIVERSIFIABLE RISK FACTORS. Identify
the types of firm-specific factors that increase a firm’s nondiversifiable risk (systematic risk).
Identify the types of firm-specific factors that increase the firm’s diversifiable risk (idiosyncratic
risk or nonsystematic risk). Why do models of risk-adjusted expected returns include no
expected return premia for diversifiable risk?
Systematic risk comes from economy wide factors like economic growth or recession,
population growth, unemployment, unexpected changes in inflation, or unexpected changes in
exchange rates (Wahlen et al., 2011). Nonsystematic risk are industry and firm specific such as
competition levels, product portfolio, frim strategy, and ability to generate growth and control
expenses (Wahlen et al., 2011). Most models include no expected risk premia for nonsystematic
risk because this can be avoided by investors by diversifying their portfolios (Wahlen et al.,
2011).
Question 11.4 DEBT AND THE WEIGHTED AVERAGE COST OF CAPITAL. Why do
investors typically accept a lower risk-adjusted rate of return on debt capital than equity capital?
