Expected return and beta as a Measure of Risk Available on Nov 16, 2022 12:01 AM....

Transcribed Image Text:

Expected return and beta as a Measure of Risk Available on Nov 16, 2022 12:01 AM. Access restricted before availability starts. Available until Nov 22, 2022 11:59 PM. Submission restricted after availability ends. Must post first. Subscribe The required return on a common stock can be computed using the Capital Asset Pricing Model (CAPM). This model was developed in the 1960's and was largely credited to William Sharpe, who won a Nobel Prize for his contribution in 1990. The CAPM uses statistical analysis to relate the risk of an individual stock to its expected return. The premise is that investors must be compensated for the time value of money and the risk of undertaking the investment. The formula for the CAPM is expressed as: RSTOCK = RRF + BLRM - RRF) Where: RSTOCK = the Return of the individual security (MSFT) RRF = the Risk-free rate of return (usually the going rate on short-term Treasury Bills) 4.65 B = the beta coefficient, a measure of riskiness of the stock relative to the riskiness of the market. A beta of 1 means that the stock has the same level of risk as the overall market. A beta of less than means less risk than the overall market, and more than 1 means it is more risky. 0.92 RM = the Return of the market -15.99% RSTOCK = RRF + B(RM-RRF) RMSFT=4.65%+ 0.92 (15.99% - 4.65%) For example, using this model we can compute the required return for IBM stock if we know a few things. We must know: 1. The going rate on Short-term Treasury Bills. This approximates the Risk- free rate. 2. The rate of return for the S&P 500. This is traditionally used to approximate the Return of the market. 3. The beta coefficient of the stock. This can be computed using the historical rates of return for the individual stock and the historical rates of return for the market using a regression analysis. Or, you can look it up on YahooFinance.com! Let's assume that the Risk-free rate is 3%, the Return of the S&P is 10%, and the Beta for IBM is 0.9. Here's our calculation: RIBM = 3% +0.9(10% -3%) = 9% This means that IBM must have a 9% return in order to compensate investors for putting their money in IBM stock instead of elsewhere. Directions: 1. Select a publicly-traded company. 2. Go to finance.yahoo.com Enter the company's stock symbol 3. Beta coefficient. 4. 52-week change for the stock 5. 52-week S&P 500 6. Next, go to Treasury.gov and search for information on US Treasury Bills. Click on the Data tab at the top. Under Interest Rates select Daily Treasury Bill rates. Then, scroll over to the 26-weeks column, and find the "coupon rate". Scroll down to the last trading day. For example, yesterday, Nov 15, the rate was 4.57%. 7. Using the information above (the stock's Beta, the rate 6-month Treasury average 52-week return for the S&P 500 compute the required rate of return for your stock. In other words, plug these numbers into the CAPM model. Requirements for your Main thread post: 1. Title your post with the name of your company! 2. Compare the required rate of return that you just computed with the 52- week change for the security. Show us your work! 3. What do you notice? How does the computed CAPM expected return compare with the actual 52-week return? 4. In your opinion, is this stock a good investment? Please explain your answer. Expected return and beta as a Measure of Risk Available on Nov 16, 2022 12:01 AM. Access restricted before availability starts. Available until Nov 22, 2022 11:59 PM. Submission restricted after availability ends. Must post first. Subscribe The required return on a common stock can be computed using the Capital Asset Pricing Model (CAPM). This model was developed in the 1960's and was largely credited to William Sharpe, who won a Nobel Prize for his contribution in 1990. The CAPM uses statistical analysis to relate the risk of an individual stock to its expected return. The premise is that investors must be compensated for the time value of money and the risk of undertaking the investment. The formula for the CAPM is expressed as: RSTOCK = RRF + BLRM - RRF) Where: RSTOCK = the Return of the individual security (MSFT) RRF = the Risk-free rate of return (usually the going rate on short-term Treasury Bills) 4.65 B = the beta coefficient, a measure of riskiness of the stock relative to the riskiness of the market. A beta of 1 means that the stock has the same level of risk as the overall market. A beta of less than means less risk than the overall market, and more than 1 means it is more risky. 0.92 RM = the Return of the market -15.99% RSTOCK = RRF + B(RM-RRF) RMSFT=4.65%+ 0.92 (15.99% - 4.65%) For example, using this model we can compute the required return for IBM stock if we know a few things. We must know: 1. The going rate on Short-term Treasury Bills. This approximates the Risk- free rate. 2. The rate of return for the S&P 500. This is traditionally used to approximate the Return of the market. 3. The beta coefficient of the stock. This can be computed using the historical rates of return for the individual stock and the historical rates of return for the market using a regression analysis. Or, you can look it up on YahooFinance.com! Let's assume that the Risk-free rate is 3%, the Return of the S&P is 10%, and the Beta for IBM is 0.9. Here's our calculation: RIBM = 3% +0.9(10% -3%) = 9% This means that IBM must have a 9% return in order to compensate investors for putting their money in IBM stock instead of elsewhere. Directions: 1. Select a publicly-traded company. 2. Go to finance.yahoo.com Enter the company's stock symbol 3. Beta coefficient. 4. 52-week change for the stock 5. 52-week S&P 500 6. Next, go to Treasury.gov and search for information on US Treasury Bills. Click on the Data tab at the top. Under Interest Rates select Daily Treasury Bill rates. Then, scroll over to the 26-weeks column, and find the "coupon rate". Scroll down to the last trading day. For example, yesterday, Nov 15, the rate was 4.57%. 7. Using the information above (the stock's Beta, the rate 6-month Treasury average 52-week return for the S&P 500 compute the required rate of return for your stock. In other words, plug these numbers into the CAPM model. Requirements for your Main thread post: 1. Title your post with the name of your company! 2. Compare the required rate of return that you just computed with the 52- week change for the security. Show us your work! 3. What do you notice? How does the computed CAPM expected return compare with the actual 52-week return? 4. In your opinion, is this stock a good investment? Please explain your answer.