Linear Equations Risk vs. Return CAPM model k=kRF + (RP * beta) where: k=the average expected rate of return (in pct) kRF=the market average riskfree rate (in pct) RP=the risk premium for an average risk investment (in pct) beta=a measure of risk relative to the average investment Input values: kRF= RP= Invested $= Memo Solution: strategy: Beta values: k= Average return= formula Dollars per year= formula 5.00% 6.00% $1,000,000 formula 1 0.00 formula 2 1.00 formula 3 0.50 formula 4 2.00 Linear Equations Risk vs. Return CAPM model k=kRF + (RP * beta) where: k=the average expected rate of return (in pct) kRF=the market average riskfree rate (in pct) RP=the risk premium for an average risk investment (in pct) beta=a measure of risk relative to the average investment Input values: kRF= RP= Invested $= Memo Solution: strategy: Beta values: k= 5.00% 6.00% $1,000,000 1 0.00 5.00% Average return= formula 10.25% Dollars per year= formula $102,500.00 2 1.00 11.00% 3 0.50 8.00% 4 2.00 17.00% To: MyBoss From : Me Date : March 21, 2015 Subject: Building Investment Calculations Based on your communication, I am showing below a way to invest the excess cash. The investment calculations are based on the proposal to average out the risks at different levels. The Capital Asset Pricing Model or CAPM provides a way to assess the return based on the risk. Since our investment is cover all aspects of risks, I am providing a model here to include the risk at four levels, 0, 50%, 100%, 200% of the yield based on the S&P benchmark returns. The spreadsheet attached uses the formula In this formula, I am using the percentage of investment as a weighting factor so that rate of return can be averaged. Since we are investing equally at each level, pi, is set to 0.25. The return is calculated then based on the formula Based on these calculations, our investment of $1 Million is expected to provide a return of $102,500. The values used in the calculations are 5% for the risk free and 11% for S&P return. Let me know if you have any questions and I would be willing to explain at more length Sincerely Me Attach: BUAD1420 Exec Memo 2.xls - Excel spreadsheet