1990 Oct. 15 142.50 638.04 - 1.75% - 8.55%
1990 Oct. 18 142.50 655.11 0.00% 2.61%
1990 Oct. 22 135.00 615.25 - 5.56% - 6.48%
1990 Oct. 25 140.00 646.67 3.57% 4.86%
1990 Oct. 26 141.25 640.44 0.88% - 0.97%
1990 Oct. 31 142.50 640. 96 0.88% 0.08%
Solution
The first step is to compute the security and market returns. This is done in columns 4
and 5 of Table 7.2. We then used a spreadsheet programme on a PC to calculate the beta.
The output from the computer was as follows:
Regression Output:
Constant 0.002049
Std Err of Y Est 0.023574
R Squared 0.362085
No. of Observations 383
Degrees of Freedom 381
X Coefficient(s) 1.245126
Std Err of Coef. 0.084669
The beta is nothing but the “X Coefficient” in the above output. The beta of ITC for the
period is therefore 1.25.
We may also compute the expected return from the ITC share based on the above
example. During the period January 1989 – October 1990, the market return was about
45% per annum, and the value of ß was 1.25. Assuming that the risk-free rate of return is
about 12%, we can use the CAPM equation to estimate the expected rate of return from
the ITC share. This works out to about 53% per annum. Where such a high return may
appear somewhat surprising at first glance, the fact remains that the period considered in
estimating the return includes one of the more bullish phases in the Indian capital market
history. Taking a much longer time period, say, five years or more, might have yielded a
more realistic estimate.
Assumptions underlying CAPM
The Capital Asset Pricing Model (CAPM) is an equilibrium model. The derivation of the
model is based on several assumptions about investors and the market, which we present
below for completeness.
Investors are assumed to take into account only two parameters of return distribution,
namely the mean and the variance, in making a choice of portfolio. In other words, it is