Introduction to Corporate Finance

7: Risk, Return and the Capital Asset Pricing Model

ST7-1 Calculate the mean, variance and standard deviations for a share with the probability distribution
outlined in the following table:

Outcome Probability Share return

Recession 10% –40%

Expansion 60% 20%

Boom 30% 50%

ST7-2 You invest $25,000 in Treasury notes and $50,000 in the market portfolio. If the risk-free rate equals
2% and the expected market risk premium is 6%, what is the expected return on your portfolio?

ST7-3 The risk-free rate equals 4%, and the expected return on the market is 10%. If a share’s expected
return is 13%, what is the share’s beta?

QUESTIONS

Q7-1 Based on the charts below, which share has more systematic risk, and which share has more
unsystematic risk?

Market return (%)

Share return (%)

Share #2

–30

–20

–10

0

10

20

30

–30 –20 –10 0 10 20 30

Market return (%)

Share return (%)

Share #1

–30

–20

–10

0

10

20

30

–30 –20 –10 0 10 20 30