Question

1. According to Reuters Finance A2M Ltd has a Beta of 1.04. In terms of share investment, define what Beta represents. What does A2M’s Beta of 1.04 mean? How risky is it?

2. The average return on the market (MKT) in Australia for the past 10 years has been 9.55% The yield on Australian 10 year treasury bonds is currently 2.29%. Using these as proxies for the Return on Market (MKT) and Risk Free Rate (Rf), combine them with the A2M Beta (above) and calculate the return expected for A2M using the Capital Asset Pricing Model (CAPM).

3. Based on your CAPM findings construct a portfolio made up of 40% A2M and 60% MKT. Calculate the estimated return and β for this portfolio.

Answer 1

1. Beta is a measure of systematic risk (risk that cant be diversified) of an investment. It tells us how risky the stock is as compared to the index or market.

Beta of A2M Ltd of 1.04 indicates that if the market goes by 1%, then the stock will rise by 1.04% and vice versa i.e. if the market falls by 1%, then the stock will fall by 1.04%

So it can be seen there is not much of a difference in the return and risk of the stock as compared to the return of market, so we can say that the stocks risk is slightly higher as compared to the market.

2. Expected return of A2M using CAPM is calculated by using the below mentioned formula i.e.

Risk Free Rate + Beta ( Return on Market - Risk Free Rate)

Risk Free Rate = 2.29%

Beta = 1.04

Return on Market = 9.55%

So by plugging these values in the above mentioned formula we shall get:

= 2.29 + 1.04 ( 9.55 - 2.29 )

= 9.84% Approximately

3. Expected return of portfolio is calculated as follows:

= Weight of A2M x Return of A2M + Weight of Market x Return of Market

= 0.4 x 0.0984 + 0.6 x 0.0955

= 9.666%

Beta of Portfolio

= Weight of A2M x Beta of A2M + Weight of Market x Beta of Market

Beta of Market is always 1

= 0.40 x 1.04 + 0.60 x 1

= 1.016

Feel free to ask in case of any query relating to this question