CAPM Question Standard Deviation wrong Given the following holding-period return

Question

CAPM Question Standard Deviation wrong

Given the following holding-period returns, compute the average returns and the standard deviations for the Sugita Corporation and for the market. b. If Sugita's beta is 0.83 and the risk-free rate is 7 percent, what would be an expected return for an investor owning Sugita? c. How does Sugita's historical average return compare with the return you should expect based on the Capital Asset Pricing Model and the firm's systematic risk? a. Given the holding-period returns shown in the table, the average monthly return for the Sugita Corporation is 2.20 %. The standard deviation for the Sugita Corporation is |6.3|%.

Explanation / Answer

Expected Returns as per CAPM:

E(R) = Rf + Beta*(Rm – Rf)
=> 7% + 0.83*(26.4% - 7%)
= 23.10%

(Note: To calculated expected return using CAPM, we generally use market return (Rm). However, in above calculation, we have used average return of the stock as Rm).

Based on CAPM, the expected return should be 23.10% per annum or 1.925% per month. While the holding period return shows that stock has returned 26.4% per annum, which is more than the expected return. This means that the stock has outperformed.

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