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Decision-making - Essay Example

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Since required rate of return serves as the basis for making economic decisions to invest or not to invest, it is therefore important that its assessment…
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Decision-making
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Decision-making

sset Pricing Model or CAPM relates the returns on one individual security with that of the market and as such it considers the risk of the market as well as the risk of the individual security. So called beta is therefore the exact measure which shows the relationship between the risk and return of the individual security with that of the market by calculating the co-variance of returns on individual security with that of the market.
CAPM also assumes that the investors are well diversified and they only attempt to reduce the systematic risk that is arising out of the market. As such beta is the measure which calculates this systematic risk and is always assumed to be 1 for the market as a whole.
The above calculations indicate that the beta calculated through two methods is different from each other. Beta-1 is calculated through the traditional method of finding the covariance and variance and then taking the ratio of two whereas beta 2 is calculated through regression analysis by taking the slope of the % change in the returns of the market and the individual security. The differences in the value of the two betas may be attributed to the relative differences in the two methodologies.
The published betas of two companies are 2.48 & 2.14 and are significantly different from calculated beta. (digitallook.com,2010. The above calculations indicate differences between the beta calculated and beta that has been published in various external sources. The changes or differences in the value of two betas may be attributed to different betas. The beta which has been calculated is based upon the closing price of the stock whereas published beta may have taken the adjusted prices of the shares while accommodating any dividends or splits. Thus the overall beta may be different from published sources if there exists a difference in calculations.
The differences in the beta can also be attributed to the geared and un-geared beta based on the method of calculation. Un-geared ... Read More
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