a What is the estimated beta coefficient of your company? What does this beta me

Question

a What is the estimated beta coefficient of your company? What does this beta mean in terms of your choice to include this company in your overall portfolio? b Given the beta of your company, the present yield to maturity on U.S. government bonds maturing in one year (currently about 4.5% annually) and an assessment that the market risk premium (that is - the difference between the expected rate of return on the 'market portfolio' and the risk-free rate of interest) is 6.5%, use the CAPM equation in order to find out what is the present 'cost of equity' of your company? Explain what is the meaning of the 'cost of equity'. c Choose two other companies, look up their "Beta" and report the names of these companies and their betas. Suppose you invest one third of your money in each of the stocks of these companies. What will the beta of the portfolio be? Given the data in (b), what will the Expected Rate of Return on this portfolio be? Do you feel that the three-stock portfolio is sufficiently diversified or does it still have risk that can be diversified away? Explain.

Explanation / Answer

The Beta is the sensivity of the stock with respect to the overall market, so a beta varies from -1 to +1, which means if a stock as -1 beta , it is negatively related to the market movement. Suppose the beta of the company is 1.2

b)THe cost of the equity = risk free rate + market risk premium * Beta = 4.5 + 6.5*1.2 = 7.8+4.5 = 12.3%

It means it is the minimum return required by the investor to invest in the company, the cost perceived by him. If the actual return is higher than this, then the investment is said to have generated a positive return.

c) When 1/3rd is investedin each of th company, this means the beta is getting averaged out overall

Eg Co A beta = 1.2m Co B is 1.5 , Co C is 0.6, so now the weighted average is

1/3*1.2 + 1/3*1.5 + 1/3*0.6 = 0.4+0.5+0.2 = 1.1

The expected return = 4.5 + 6.5 * 1.1 = 11.65%

The portfolio still has unsystematic risk , the systematic risk is diversified by investing in diverse stocks .However, in this case , all the stocks are poitively related to market.So, entire risk is not diversed away.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.