Please answer the questions below based on the following statements:

l Early in 1998, Apple was in huge trouble and its shares were more volatile than those of a rival, IBM. Yet, Apple’s cost of equity was lower than that of IBM’s. Later on, Apple’s cost of capital rose even though its financial situation improved.

l The fundamental insight behind the CAPM is that investors require higher (expected)

returns for bearing more risk. Risk is decomposed into two parts, alpha and beta.

l The extent of a stock’s volatility is picked up by the beta coefficient. Apple’s beta was 0.50 and that of IMB’s 1.1.

l Good bye CAPM? Not so fast! As long as investors are able to construct well-diversified portfolios, they will be able to be concerned only with market risk.

a. Which piece of news above implies “market risk” and “Apple’s average return”.

b. How volatile is Apple’s stock and how volatile is IBM’s? Compare the two stocks.

c. Can you explain why Apple’s shares did not move as much as the market and, if so, what were investors reacting to?

d. Should one discard CAPM? In answering this question, read once again the box Lessons of Our Times above. Is beta relevant in this case? Discuss.