Question

EVALUATION OF PORTFOLIO BETA AND THE REQUIRED RETURN ON STOCK The tendency of a stock's price to move up and down with the market is reflected in its beta coefficient. Therefore, beta is a measure of an investment's market risk, and is a key element of the CAPM. In this part of the project, you get financial information using Yahoo!Finance (found athttp://finance.yahoo.com/ ) and www.money.cnn.com To find a company's beta, enter the desired stock symbol and request a basic quote. Once you have the basic quote, select the "Statistics". Scroll down this page to find the stock's beta. In your initial response to the topic you have to answer all 5 questions. You are expected to make your own contribution in a main topic as well as respond with value added comments to at least two of your classmates as well as to your instructor. From Yahoo!Finance obtain a report on any two companies. What are the betas listed for these companies? If you made an equal dollar investment in each stocks what would be the beta of your portfolio? Please how your work. If you made 70% of dollar investment in stock A, and 30% of dollar investment in stock B, what would be the beta of your portfolio? Please how your work. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate the required return on both stock. Note that you will need the risk-free rate and the market return. a) To get the current yield on 10-year Treasury securities go to Finance!Yahoo’s at www.finance.yahoo.com -click on Market Data - U.S. Treasury Bonds. You will use the current yield on 10-year Treasury securities as the risk-free rate to estimate the required rate of return on stocks. b) Between 1926 and 2014, the compound annual rate of return of S&P 500 is estimated a 10.5%. We will use this number as the market return. c) Calculate the required return on both stock using the Capital Asset Pricing Model (CAPM) Security Market Line. Please show your work. Find on the Internet the 52-weeks change of the stock price. Compare the required return on these stocks calculated using CAPM against their historical return over the last 52 weeks. Is there a difference between these returns? Are these stock overvalued, undervalued, or properly valued? Why? In accordance with your founding, is it reasonable for the investor to buy any of these stocks? Explain your answers. 9 0

Answer 1

Selected company's are Exxon Mobild Corporation and Chevron Corporation.

Exxon Mobil Corp Beta = Be = 0.7 and Chevron Corp Beta = Bc = 1.32

(Beta quotes taken from Yahoo Finance as instructed in the question)

If an equal dollar investment is made in both stocks then the weight (by dollar value) of each stock in the portfolio will be 0.5 each.

Therefore, Portfolio Beta = Bp = Bc x 0.5 + Be x 0.5 = 1.32 x 0.5 + 0.7 x 0.5 = 1.01

Let Stock A be Exxon Mobil Corp and Stock B be Chevron.

Then weight of Exxon = 0.7 and weight of Chevron = 0.3

Therefore, Portfolio Beta = Bp = 0.7 x 0.7 + 0.3 x 1.32 = 0.886

US Treasury Bond Yields = 2.705% (Source " yahoon finance and bloomberg.com")

Risk Free Rate = Rf = 2.705 % and Market Return = 10.5%=Rm

Using CAPM:

Required Return on Exxon Mobil = Re = Rf + Be x (Rm - Rf) = 2.705 + 0.7 x (10.5 - 2.705) = 8.1615 %

Reuired Return on Chevron Corp = Rc = Rf + Bc x (Rm - Rf) = 2.705 + 1.32 x (10.5 - 2.705) = 12.9944%

Exxon Mobil 52 week Stock price:

One Year Ago = $ 83.31 and Today = $ 79.72

52 weeks Return = [(79.72 - 83,31) / 83.31] x 100 = - 4.31 %

As the CAPM Rate of Return is higher than the actual rate of return, it implies that the Exxon stock is undervalued and hence should be bought,

Chevron Corp:

One Year Ago = $ 112.98, Today (latest) = $ 113.90

52 weeks Return = [(113.9 - 112.98) / 112.98] x 100 = 0.814 %

As the CAPM rate of return is higher than the actual rate of return even the Chevron stock is undervalued and should be bought.