Capital Asset Pricing Model
Part A
According to Pahl (2009), beta comes in handy in describing the returns of a given portfolio or stock in relation to the whole market’s returns. For instance, we would say that an asset has a nil beta if the changes in the returns of the market do not affect that particular product. Hence the estimated beta coefficient of Fed Ex is 1.36 given the Market Beta and the FedEx stock and market correlation. This essentially means that the market returns shall generally be followed by the returns of the asset. Given that the markets are now looking us after the recession that hit the same in the recent past, including FedEx in my overall portfolio would be a wise investment decision.
Part B
r = Rf + beta * (RM – Rf)
Where
r = security expected return rate
Rf = Risk free investment rate
RM = appropriate asset class return rate
Hence in this case,
0.065 = Rf + 1.36 (0.045- Rf)
0.065= Rf+ 0.0612 – 1.36Rf
0.36Rf = -0.0038
Rf = -0.011
The cost of equity in this case mirrors the individual shareholders investment opportunity cost.
Part c
For my analysis in this case, I concern myself with Lowe’s and Home Depot. Lowe’s stock beta is 0.83 while Home Depot has a stock beta of 0.869. On investing 33% of my money in Lowe’s, the contribution in this case would be;
The percentage invested * return on the stock
0.33 * (0.83 * 0.045) = 0.01233
When it comes to Home Deport;
The percentage invested * return on the stock
0.33 * (0.869* 0.045) = 0.1290
In regard to the expected rate of return,
Ks = Krf + B (Km – Krf);
Where; Ks= expected rate of return, Krf = risk free rate, B= beta, Km = the expected rate of return on asset
For Home depot
Ks = 0.065 + 0.869 (0.045 – 0.065) = 0.0476
For Lowe’s;
Ks = 0.065 + 0.83 (0.045 – 0.065) = 0.0484
In my opinion, the three-stock portfolio is sufficiently diversified and with that in mind, only a minimal amount of risk can be diversified away.
References
Pahl, N. (2009). Principles of the Capital Asset Pricing Model and the Importance in
Firm Valuation. GRIN Verlag
Is this your assignment or some part of it?
We can do it for you! Click to Order!
