4.Consider a market portfolio that has a standard deviation of 0.30.The average degree of risk aversion is 2.If the expected return on the market portfolio is 0.25,what is the equation for the Capital Market Line? Answer: E(rM)-rf =2x0.32 =0.18 =0.25-0.18 =0.07 The equation for CML: Er=0.07+0.60o 5.Apart from portfolio selection,discuss other applications of the CAPM in finance. Answer: Risk premiums derived from the CAPM are used in capital-budgeting decisions of the firm and in discounted cash flow valuation models.The CAPM is also used to establish "fair"rates ofreturn on invested capital in regulated firms and in "cost plus"pricing. 6.Two industrial firms are considering a merger.Comdat has a beta of 1.15 and BioTech has a beta of 1.95.Comdat's stock sells for $60 per share and there are 6 million shares outstanding.BioTech has 4 million shares outstanding and its stock sells for $90 per share.If the merger is carried out,what will be the merged firm's beta? Answer: Comdat's market value S60 x 6 million =S360,000.000 BioTech's market value S90x 4.000.000 =S360.000,000 Comdat weight =0.5 BioTech weight 0.5 Merged beta=0.5)l.15)+0.5)l.95) =1.55 13-1413-14 4. Consider a market portfolio that has a standard deviation of 0.30. The average degree of risk aversion is 2. If the expected return on the market portfolio is 0.25, what is the equation for the Capital Market Line? Answer: E(rM) - rf = 2 x (0.3)2 = 0.18 rf = 0.25 – 0.18 = 0.07 The equation for CML: E(r) = 0.07 + 0.60σ 5. Apart from portfolio selection, discuss other applications of the CAPM in finance. Answer: Risk premiums derived from the CAPM are used in capital-budgeting decisions of the firm and in discounted cash flow valuation models. The CAPM is also used to establish "fair" rates of return on invested capital in regulated firms and in “cost plus” pricing. 6. Two industrial firms are considering a merger. Comdat has a beta of 1.15 and BioTech has a beta of 1.95. Comdat's stock sells for $60 per share and there are 6 million shares outstanding. BioTech has 4 million shares outstanding and its stock sells for $90 per share. If the merger is carried out, what will be the merged firm's beta? Answer: Comdat's market value = $60 x 6 million = $360,000,000 BioTech's market value = $90 x 4,000,000 = $360,000,000 Comdat weight = 0.5 BioTech weight = 0.5 Merged beta = (0.5)(1.15) + (0.5)(1.95) = 1.55