RISK, RETURN AND THE CAPITAL
ASSET PRICING MODEL
7-1 Expected returns
7-2 Risk and return for portfolios
7-3 Pulling it all together: the CAPM
7-4 Are share returns predictable?
THE HIGH-BETA RALLY
The notion that a share’s beta is an important
measure of risk and is linked to an investment’s
return is fundamental to one of the most important
theories in all of finance: the capital asset pricing
model (CAPM). The CAPM gives investors a way
to judge the risks and rewards of almost any
investment, and managers rely on the model
when they analyse capital investment projects for
their companies. We can see this in practice by
assessing the behaviour of shares with high betas.
The CAPM implies that if a company’s share price
has a high beta associated with it, the company’s
shares are considered to be more risky or volatile,
suggesting that the share price is going to move up
and down more dramatically than the share prices
of companies that the market perceives as less risky.
Thus when a major market upswing occurs, this can
be driven by a rise in the price of high-beta shares.Traders refer to this as a ‘high-beta rally’. An
example occurred in the final day of trading in
2012 and the first day of trading in 2013 in the US.
Following the euphoria of escaping the so-called
‘fiscal cliff’, the US market displayed a massive
two-day surge in value, with 31 December 2012
producing the largest final-day gain since 1974.
However, this surge was mainly due to a massive
rise in the value of high-beta shares. The S&P 500
High Beta Index (listed as the SPHB) consists of the
100 shares from the S&P 500 Index with the highest
sensitivity to market movements, or beta, over
the past 12 months as determined by Standard &
Poor’s. The following chart shows how it performed
compared to the S&P 500 Index (SP500) over the
last quarter of 2012 and beginning of 2013. The
chart demonstrates how this two-day surge in value
was driven by high beta shares.
Source: ‘Crossing Wall Street’, CWS Market Review, 4 January 2013what companies doExpressBring your learning to life with interactive learning, study, and exam preparation tools that support the printed
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