Entrepreneurial Finance Assignment 1 - 2511 Words

Entrepreneurial finance assignment 1 Problem 4.4. Introduction The CAPM model can be used to analyze the performance of a portfolio of investments. The model should be calculated by comparing the return of assets (Ri) minus the return of risk-free cash (Rf) of the fund against those numbers of a known index with historical data (Rm). With least-squares regression, a straight line has to be drawn through the points to finish the model. Alpha represents the point where the graph starts and beta the slope of the regression line. Alpha is the number that represents the fact of how well the fund did against the CAPM model. A positive alpha means the fund did better than CAPM predicted and negative the opposite. R ² represents the ‘fit’†¦show more content†¦This results in an adjusted regression equation defined as: Because the model used to calculate the regression does not entail the stale value problem, we consider the concern of Bonnie as valid. (c) Chris thinks that this model does not properly adjust for the high probability of failure for VC investments. This concern is invalid. The unexpected portion of the return (and thereby referring to the higher risk) is represented by alpha. A higher alpha means that the portfolio performance was better than the original CAPM model. A lower alpha means that the performance was worse. (d) Dave thinks that this model does not properly adjust for the illiquidity of VC investments. This concern is valid. Dave refers to one of the other three interpretation problems of CAPM results; liquidity risk. Investors may require a premium for illiquid investments. They refer to it that investments that are illiquid are more risky. The model presented by the management team does not take this risk into account. To overcome this, the management team should use the Pastor-Stambaugh model (adjustment 2 of the CAPM model) which takes the size (of the company), value (growth prospects) and liquidity risk of an investment into account. This model is defined as: (e) Ellen thinks something else is wrong, but she can’t put her finger on it. Ellen could be thinking of another points, that the model is not adjusted for ‘styleShow MoreRelatedEntrepreneurial Finance Assignment 12519 Words   |  11 PagesEntrepreneurial finance assignment 1 Problem 4.4. Introduction The CAPM model can be used to analyze the performance of a portfolio of investments. The model should be calculated by comparing the return of assets (Ri) minus the return of risk-free cash (Rf) of the fund against those numbers of a known index with historical data (Rm). With least-squares regression, a straight line has to be drawn through the points to finish the model. 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