- 44 -
its stock are subject to regulatory approval.19 Finally, CAPM
assumes that investors hold, or have the ability to hold,
diversified portfolios that eliminate, on a portfolio basis, the
effects of unsystematic risk--the elements of risk that are
specific to the asset held. Consequently, because CAPM assumes
that an investor holding a diversified portfolio will encounter
only systematic risk, the only type of risk for which an investor
can be compensated is systematic or market risk, which represents
the sensitivity of the future returns from a given asset to the
movements of the market as a whole. See id. (citing Brealey &
Myers, Principles of Corporate Finance 137-138, 143-144 (4th ed.
1991); Pratt et al., Valuing a Business 166 (3d ed. 1996)).
In calculating Peoples' discount rate, Mr. Fuller followed
the principles of CAPM and did not make any provision for
Peoples' unsystematic risk, based on the assumption that such
risk was diversifiable. Yet respondent and Mr. Fuller have
overlooked the difficulties in diversifying an investment in a
block of stock they argued is worth approximately $8.94 million.
Construction of a diversified portfolio that will eliminate most
unsystematic risk requires from 10 to 20 securities of similar
value. See Brealey & Myers, supra at 137-139. Thus, proper
diversification of an investment in the Peoples shares owned by
19 An acquisition of greater than a 24.9-percent interest
requires Federal regulatory approval.
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