BUSF_A01.qxd

Chapter 7 • Portfolio theory and its relevance to real investment decisions

CAPM was developed by Sharpe (1963), though others independently reached sim-

ilar conclusions at round about the same time.

7.6 CAPM: an example of beta estimation

We shall now take a look at how the beta for the ordinary shares of a particular busi-

ness may be derived.

Figure 7.8
Graphical
representation

7.7 Assumptions of CAPM

security market line

Where there is no risk, the expected return is the risk-free rate. As systematic risk (measured

by b) increases, an increasingly large risk premium, over the risk-free rate, is expected.

The year-end level of a representative stock exchange index and of the price of an ordinary

share of Ace plc were as follows:

Year Index Ace plc ( £)

1998 218 1.09

1999 230 1.20

2000 248 1.33

2001 250 1.40

2002 282 1.80

2003 297 1.99

2004 288 1.81

2005 290 1.98

2006 320 2.25

2007 356 2.55

2008 371 2.80

You are required on the basis of the above to calculate beta. (Ignore dividends throughout.)

Example 7.3