268 Part 3 Financial Assets
Access the Thomson ONE problems through the CengageNOW™ web site. Use the Thomson ONE—Business School Edition online
database to work this chapter’s questions.Using Past Information to Estimate Required Returns
Chapter 8 discussed the basic trade-off between risk and return. In the Capital Asset Pricing Model
(CAPM) discussion, beta was identi" ed as the correct measure of risk for diversi" ed shareholders. Recall
that beta measures the extent to which the returns of a given stock move with the stock market. When
using the CAPM to estimate required returns, we would like to know how the stock will move with the
market in the future; but since we don’t have a crystal ball, we generally use historical data to estimate
this relationship with beta.
As mentioned in the Web Appendix for this chapter, beta can be estimated by regressing the individ-
ual stock’s returns against the returns of the overall market. As an alternative to running our own regres-
sions, we can rely on reported betas from a variety of sources. These published sources make it easy for
us to readily obtain beta estimates for most large publicly traded corporations. However, a word of cau-
tion is in order. Beta estimates can often be quite sensitive to the time period in which the data are esti-
mated, the market index used, and the frequency of the data used. Therefore, it is not uncommon to " nd
a wide range of beta estimates among the various published sources. Indeed, Thomson One reports
multiple beta estimates. These multiple estimates re! ect the fact that Thomson One puts together data
from a variety of different sources.Discussion Questions
- Begin by looking at the historical performance of the overall stock market. If you want to see, for example, the
performance of the S&P 500, select “INDICES” and enter S&PCOMP. Click on “PERFORMANCE.” You will see
a quick summary of the market’s performance in recent months and years. How has the market performed over
the past year? the past 3 years? the past 5 years? the past 10 years? - Now let’s take a closer look at the stocks of four companies: Colgate Palmolive (Ticker = CL), Campbell Soup
(CPB), Motorola (MOT), and Tiffany & Co (TIF). Before looking at the data, which of these companies would
you expect to have a relatively high beta (greater than 1.0) and which of these companies would you expect to
have a relatively low beta (less than 1.0)? - Select one of the four stocks listed in Question 2 by selecting “COMPANY ANALYSIS,” entering the company’s
ticker symbol in the blank companies box, and clicking “GO.” On the company overview page, you should see
a chart that summarizes how the stock has done relative to the S&P 500 over the past 6 months. Has the stock
outperformed or underperformed the overall market during this time period? - If you scroll down the company overview page, you should see an estimate of the company’s beta. What is the
company’s beta? What was the source of the estimated beta? - Click on “PRICES” on the left-hand side of the screen. What is the company’s current dividend yield? What has
been its total return to investors over the past 6 months? over the past year? over the past 3 years? (Remember
that total return includes the dividend yield plus any capital gains or losses.) - Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the required return on the
company’s stock? - Repeat the same exercise for each of the 3 remaining companies. Do the reported betas confirm your earlier in-
tuition? In general, do you find that the higher-beta stocks tend to do better in up markets and worse in down
markets? Explain.
Discussion Questions
- Begin by looking at the historical performance of the overall stock market. If you want to see, for example, the
performance of the S&P 500, select “INDICES” and enter S&PCOMP. Click on “PERFORMANCE.” You will see
a quick summary of the market’s performance in recent months and years. How has the market performed over
the past year? the past 3 years? the past 5 years? the past 10 years? - Now let’s take a closer look at the stocks of four companies: Colgate Palmolive (Ticker = CL), Campbell Soup
(CPB), Motorola (MOT), and Tiffany & Co (TIF). Before looking at the data, which of these companies would
you expect to have a relatively high beta (greater than 1.0) and which of these companies would you expect to
have a relatively low beta (less than 1.0)? - Select one of the four stocks listed in Question 2 by selecting “COMPANY ANALYSIS,” entering the company’s
ticker symbol in the blank companies box, and clicking “GO.” On the company overview page, you should see
a chart that summarizes how the stock has done relative to the S&P 500 over the past 6 months. Has the stock
outperformed or underperformed the overall market during this time period? - If you scroll down the company overview page, you should see an estimate of the company’s beta. What is the
company’s beta? What was the source of the estimated beta? - Click on “PRICES” on the left-hand side of the screen. What is the company’s current dividend yield? What has
been its total return to investors over the past 6 months? over the past year? over the past 3 years? (Remember
that total return includes the dividend yield plus any capital gains or losses.) - Assume that the risk-free rate is 5% and the market risk premium is 6%. What is the required return on the
company’s stock? - Repeat the same exercise for each of the 3 remaining companies. Do the reported betas confirm your earlier in-
tuition? In general, do you find that the higher-beta stocks tend to do better in up markets and worse in down
markets? Explain.