Question

This question relates to Topic 4 and LO’s 1, 2, 3, 5, 6
a. In terms of share investment define what beta (β) represents. [2.5 marks]
b. According to au.finance.yahoo.com, APT has a beta of 1.88. What does this mean? [2.5
marks]
c. In terms of riskiness how would you compare APT’s beta to the market? [2.5 marks]
d. Calculate the expected returns for APT using the Capital Asset Pricing Model (CAPM)
and the following yields. [5 marks]
• The risk free rate (Rf) as measured by the yield on Australian 10 year treasury
bonds is 1.5% p.a.
• The average return on the market for the past 10 years has been 10.5% p.a.
• Use the APT beta (β) of 1.88.
e. i. Using the CAPM data from (d), create an Excel scatter plot graph to plot the Security
Market Line (SML)using the Rf, return on the market and APT. [5 marks]
ii. Based on your CAPM findings, construct a portfolio made up of 40% market and 60%
APT. Calculate the estimated return and beta for this portfolio. [2.5 marks

Answer 1

a.) Beta represents the volatility of a stock return relative to the returns of the entire market. The Beta is a critical component of the Capital Asset pricing model, which models the required rate of return on a stock given the risk factor (Beta) of that stock. A company with a higher Beta has greater risks and hence greater required returns

b) A beta of >1 indicates that the stock is more volatile than the average market returns. Accordingly, the stock demands a higher return in order to compensate for the excess risks taken.

c) Market returns have a beta of 1. A beta of 1.88 implies that APT returns should be 88% more than the market returns, while at the same time, riskier than the market returns.

d) According to the CAPM equation, the required rate of return on APT is given by

where is the risk-free rate = 1.5%

is the average market return = 10.5%

= 1.88

= 0.015+ 1.88*(0.105-0.015)

=18.42%

e) i.

R(m)	10.50%
R(f)	1.50%

Beta	E(APT)
0.05	1.95%
0.1	2.40%
0.15	2.85%
0.2	3.30%
0.25	3.75%
0.3	4.20%
0.35	4.65%
0.4	5.10%
0.45	5.55%
0.5	6.00%
0.55	6.45%
0.6	6.90%
0.65	7.35%
0.7	7.80%
0.75	8.25%
0.8	8.70%
0.85	9.15%
0.9	9.60%
0.95	10.05%
1	10.50%
1.05	10.95%
1.1	11.40%
1.15	11.85%
1.2	12.30%
1.25	12.75%
1.3	13.20%
1.35	13.65%
1.4	14.10%
1.45	14.55%
1.5	15.00%
1.55	15.45%
1.6	15.90%
1.65	16.35%
1.7	16.80%
1.75	17.25%
1.8	17.70%
1.85	18.15%
1.9	18.60%
1.95	19.05%
2	19.50%
2.05	19.95%
2.1	20.40%
2.15	20.85%
2.2	21.30%
2.25	21.75%
2.3	22.20%
2.35	22.65%
2.4	23.10%
2.45	23.55%
2.5	24.00%

e) ii.

The expected return on the portfolio is

w(APT)= 0.6

w(m)=0.4

E(APT) = 0.1842

E(M) = 0.105

= 0.6*0.1842 + 0.4*0.105 = 15.25%

From the CAPM equation, Beta of the portfolio is given by

= (0.1525-0.015) / (0.105-0.015) = 1.53