You are provided with the following monthly expected returns, each of which is r
ID: 2764499 • Letter: Y
Question
You are provided with the following monthly expected returns, each of which is represented by E(Ri), and betas for the following stocks. Please estimate the capital asset pricing model and draw conclusions about the significance and realism of the results. (Note: Please use conventional tests of the R-squared and coefficients.) On the basis of your results, please name at least three of the stocks that you would recommend as “buys.”
E(Ri) Beta
AA
0.8
1.3
AXP
0.8
1
BA
1
0.80
C
0.8
1.35
CAT
1.2
1.7
CSCO
0.6
0.95
KO
0.4
0.6
DIS
0.6
0.95
DD
0.6
0.7
ED
0.4
0.55
XOM
0.4
0.6
GE
0.5
0.9
GM
0.6
0.8
HPQ
0.4
1.3
HD
0.4
0.9
HON
0.9
1.15
INTC
0.8
1.1
IBM
0.9
1.4
IP
0.4
0.80
JNJ
0.3
0.35
MCD
0.6
0.5
MSFT
0.8
1.2
MMM
0.5
0.9
JPM
0.9
1.70
PG
0.4
0.45
SYK
0.6
0.4
T
0.6
1
UTX
1.1
1.1
WMT
1
0.8
WPC
0.7
1.2
AA
0.8
1.3
AXP
0.8
1
BA
1
0.80
C
0.8
1.35
CAT
1.2
1.7
CSCO
0.6
0.95
KO
0.4
0.6
DIS
0.6
0.95
DD
0.6
0.7
ED
0.4
0.55
XOM
0.4
0.6
GE
0.5
0.9
GM
0.6
0.8
HPQ
0.4
1.3
HD
0.4
0.9
HON
0.9
1.15
INTC
0.8
1.1
IBM
0.9
1.4
IP
0.4
0.80
JNJ
0.3
0.35
MCD
0.6
0.5
MSFT
0.8
1.2
MMM
0.5
0.9
JPM
0.9
1.70
PG
0.4
0.45
SYK
0.6
0.4
T
0.6
1
UTX
1.1
1.1
WMT
1
0.8
WPC
0.7
1.2
Explanation / Answer
According to capital asset pricing model, the higher the risk associated with the stock, higher the returns.
In other words, when the beta of the stock is higher, the returns should be higher. In general, the index will have a beta of 1. So the stock with beta greater than 1 are suppose they perform better than the index and will have higher volatility and stocks with beta lesser than 1 will have lower volatility.
Buying three stocks will be a result of my risk aversion. I would like to purchase three stock which a beta nearly equal to 1 or somewhere there since I would like to follow the market returns and dislike highly volatile stock with large betas.
Hence I would choose the stocks: AXP, HON and UTX for my portfolio.
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