Project3: Evaluating Stock Risk and Return
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 exercise, you get financial information using Yahoo!Finance (found at http://finance.yahoo.com). To find a company’s beta, enter the desired stock symbol and request a basic quote. Once you have the basic quote, scroll down the summary page to find the stock’s beta.
a. From Yahoo!Finance, identify the beta listed for the stocks of four companies: a food service (restaurant) company called Denny’s Corporation (stock symbol DENN), Amazon (AMZN), Caterpillar Inc. (CAT), and Waste Management (WM). Which company (or companies) has higher beta (greater than 1.0)? And which company (or companies) has lower beta (less than 1.0)? Why?
b. If you made an equal dollar investment in each of the four stocks, Denny’s Corporation, Amazon, Caterpillar Inc., and Ford Motor Company, what would be the beta of your portfolio?
c. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate the required return on Caterpillar stock.
Assumptions and Data: Note that you will need an estimate of the risk-free rate, rRF, and the market risk premium. Assume a 5% market risk premium and use the current yield on 10-year Treasury securities as an estimate of the risk-free rate. You can yields on Treasury securities from the section of “Market Data” on Finance!Yahoo’s frontpage.
d. Compare the required return of Caterpillar against its return over the last 52 weeks (Click on “Statistics” once you get the firm’s quote page, and find the “52-Week Change”). Is there a difference between these returns? Why is there a difference? (Hint: Think about the limitations of the CAPM model)