Finance

Assignment

Word limit: 2000 words.

Q1. Pick any three companies with shares currently listed on the ASX that have been trading for at least five years. Go to DatAnalysis (accessible via Deakin Library website) and download the adjusted month-­end closing stock prices of these companies for the previous 61 months ended 31/10/2014 onto a MS Excel spreadsheet. Use the downloaded data and perform necessary calculations to answer the questions a) to c):

a) Compute the individual monthly returns, average monthly return, variance and standard deviation of the monthly returns for the stocks of the companies you have chosen.

b) Using the various statistics calculated in a), state which stock has the highest expected return, which stock has the highest total risk and which one has the highest expected return per unit of total risk.

c) Would the stock with the highest total risk in b) necessarily be the ‘riskiest' of the three stocks? Explain.

Go to Yahoo Finance and download the adjusted month-­-end closing value of the ASX All Ordinaries Index (AORD) for last 61 months ended 31/10/2014. Perform necessary calculations to answer questions d) to f):

d) Use the month-­-end adjusted closing values of the AORD to compute individual monthly returns on the market index.

e) Briefly describe the beta estimation process as per the CAPM. Using the information in d) along with the individual monthly returns on each of the three stocks calculated in a), estimate their betas. What do these betas tell you about the riskiness of these three stocks relative to the market? Assuming a 3%

a. risk-­-free rate, calculate the expected return on each of the three stocks using CAPM.

f) What would happen to the expected rates of return for a risk-­-free rate of 4.5% per annum? What would they be if the risk-­-free rate was 1.5%? Explain your observations in light of the risk-­-return relationship.

Q2. The application of the CAPM in modern financial markets has been much debated and criticized from an empirical point of view. Does this imply that the theory underlying CAPM is flawed? Outline your argument. Should we reject the model outright? If you think that the model should be rejected, provide alternative model(s) to replace it with empirical studies to support your choice. Otherwise, provide the
reasons why CAPM should be kept. (Maximum 1000 words for Q2)