Essay About Whole Stock Market And Basic Measures Of Variation

Case: Capital Asset Pricing Model
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Case: Capital Asset Pricing ModelThe Capital Asset Pricing Model (CAPM) describes the relationship between returns on a speculative asset (typically returns on stock) and returns on the whole stock market. The underlying theory describes the risk of owning an asset, where risk refers to variation in returns over time. Part of the risk of owning an asset is associated with overall movements in the market as a whole and so is called market risk. The remaining idiosyncratic risk is unique to the asset. The underlying theory promises that markets will pay investors for taking market risk, but not for assuming idiosyncratic risk, which it treats as a gamble. According to the CAPM, a simple regression model describes the returns   Rt   on a stock  over some time period as  Rt = α + βMt + Ɛt     where  Mt   is the return on the market and  Ɛt    denotes the effects of other factors on the stock return. The intercept α is called the alpha of the stock, and the slope β is called the beta of the stock.  The data capm.jmp for this example give monthly returns on Berkshire Hathaway and the overall stock market since January 1980. Use these data to fit the CAPM regression and check whether the simple regression model is appropriate. Answer the following questions:[pic 1][pic 2][pic 3]1. If β = 0, do movements in the market influence the value of the stock?No, if the stock’s Beta equals zero then that means it is not correlated with the market.2.  If β = 1, does the stock tend to move up and down with changes in the market?Yes, if the stock’s beta is 1 that indicates that the portfolio will move in the same direction and will have the same volatility as the market and is sensitive to systematic risk.3. What kinds of stocks have stock beta: β • 1, β < 1, or β < 0? Give some examples.A beta less than 0 indicates that it moves in the opposite direction of the market.Examples: Stocks of debt collection companies, SH (ProShares Short S&P 500), SPXU (ProShares UltraPro Short S&P 500).A beta between 0 and 1 signifies that it moves in the same direction as the market, with less volatility.Examples: [pic 4]A beta greater than 1 indicates that the portfolio will move in the same direction as the market, with a higher magnitude, and is very sensitive to systematic risk.Examples: Apple, Amazon[pic 5]Sources: CAPM shows that the cost of equity capital is determined only by beta (β); hence, α = 0. “An alpha of zero would indicate that the portfolio or fund is tracking perfectly with the benchmark index and that the manager has not added or lost any value” (