The board of a bank is reviewing their investment methodology as they have a new

project under consideration. They have agreed that using the CAPM approach is

sensible as they feel it likely that most of their shareholders will have a well$-$

diversified shareholding in the stock market as a whole.

There has been some dispute about which risks constitute specific risks in the bank

and which risks are more systematic in nature partly driven by the nature of the

banks operations. Equally, no one seems quite sure what the required return derived

from the CAPM formula actually represents. The finance director has produced the

following data related to the financial institution itself, the financial market and the

new project it is considering:

Required return on existing debt: $6\mathrm{.}0\%$

Cost of existing debt to the bank: $4\mathrm{.}8\%$

Returns on short$-$term government securities: $5\mathrm{.}2\%$

Required:

Identify a systematic risk in this

case.

Return in the stock market: $12\mathrm{.}8\%$

Based on the data given in the

question, compute risk free rate of

Equity beta of the bank: $1\mathrm{.}35$

return.

Beta of the new project: $1\mathrm{.}52$

Compute the required rate of

Asset beta of the bank: $1\mathrm{.}15$

return on the new project.