Question

Based on five years of monthly data, you derive the following information for the companies listed:

Company	ai (Intercept)	σi		riM
Intel	0.23	12.90	%	0.77
Ford	0.13	15.80		0.35
Anheuser Busch	0.20	6.40		0.69
Merck	0.05	9.50		0.77
S&P 500	0.00	6.00		1.00

1. Compute the beta coefficient for each stock. Do not round intermediate calculations. Round your answers to three decimal places.

   Intel:

   Ford:

   Anheuser Busch:

   Merck:

2. Assuming a risk-free rate of 7 percent and an expected return for the market portfolio of 13 percent, compute the expected (required) return for all the stocks. Do not round intermediate calculations. Round your answers to two decimal places.

   Intel:   %

   Ford:   %

   Anheuser Busch:   %

   Merck:   %

3. Choose the correct SML graph for the following estimated returns for the next year.
   • Intel — 18 percent
   • Ford — 14 percent
   • Anheuser Busch — 18 percent
   • Merck — 11 percent

   The correct graph is -Select-graph Agraph Bgraph Cgraph DItem 9 .

   A.
   B.
   C.
   D.

   Which stocks are undervalued or overvalued?

   Company	Evaluation
   Intel	-Select-UndervaluedOvervaluedItem 10
   Ford	-Select-UndervaluedOvervaluedItem 11
   Anheuser Busch	-Select-UndervaluedOvervaluedItem 12
   Merck	-Select-UndervaluedOvervaluedItem 13

Answer 1

(a.)

  

= Beta

= Covariance between market & security

= Variance of Market = = ( 0.06 )² = 0.0036

  

Company	Covariance	Beta
Intel	0.77 * 0.1290 * 0.06 = 0.0059598	0.0059598 / 0.0036 = 1.6555
Ford	0.35 * 0.1580 * 0.06 = 0.003318	0.003318 / 0.0036 = 0.9217
Anheuser Busch	0.69 * 0.0640 * 0.06 = 0.0026496	0.0026496 / 0.0036 = 0.736
Merck	0.77 * 0.0950 * 0.06 = 0.004389	0.004389 / 0.0036 = 1.2192

So Beta of

Intel : 1.656

Ford : 0.922

Anheuser Busch : 0.736

Merck : 1.219   

(b.) R_f = 7%

R_m = 13%

on the basis of CAPM expected return (ER) is

ER = R_f + * ( R_m - R_f )

R_m - R_f = 13% - 7% = 6%

Company	Expected Return
Intel	7 + 1.656 * 6 = 7 + 9.936 = 16.936
Ford	7 + 0.922 * 6 = 7 + 5.532 = 12.532
Anheuser Busch	7 + 0.736 * 6 = 7 + 4.416 = 11.416
Merck	7 + 1.219 * 6 = 7 + 7.314 = 14.314

So Expected Return of

Intel : 16.94%

Ford : 12.53%

Anheuser Busch : 11.42%

Merck : 14.31%

(c)

Security market line  exhibits relationship between expected return (calculated on the basis of CAPM ) and their beta. If estimate return plotted above SML, considered Undervalued and if estimate return plotted below SML, considered Overvalued.

Company		Expected Return	Beta	Estimate return	Valuation
Intel	In	16.94	1.656	18	Undervalued
Ford	Fo	12.53	0.922	14	Undervalued
Anheuser Busch	Ab	11.42	0.736	18	Undervalued
Merck	Me	14.31	1.219	11	Overvalued