solution

In the Capital Asset Pricing Model (CAPM) discussion, beta is identified as the correct measure of risk for diversified shareholders. Recall that beta measures the extent to which the returns of a given stock move with the stock market. When using the CAPM to estimate required returns, we would ideally like to know how the stock will move with the market in the future, but because we don’t have a crystal ball we generally use historical data to estimate this relationship. As noted in the chapter, beta can be estimated by regressing the individual stock’s returns against the returns of the overall market. As an alternative to running our own regressions, we can instead rely on reported betas from a variety of sources. These published sources make it easy to obtain beta estimates for most large publicly traded corporations. However, a word of caution is in order. Beta estimates can often be quite sensitive to the time period in which the data are estimated, the market index used, and the frequency of the data used. Therefore, it is not uncommon to find a wide range of beta estimates among the various published sources. 1. Find a chart for Apple (AAPL) that summarizes how the stock has done relative to the S&P 500 over the past years. Has the stock outperformed or underperformed the overall market during the past year? The past 5 years? 2. What is the firm’s beta according to Yahoo Finance? Is it possible that you will find different beta from other financial websites? 3. Assume that the risk-free rate is 3% and that the market risk premium is 6%. What is the required return on the company’s stock? (using the beta estimation from Yahoo Finance) 4. Repeat the same exercise for Procter and Gamble (PG). Do the reported betas confirm your earlier intuition? In general, do you find that the higher-beta stocks tend to do better in up markets and worse in down markets? Explain.