CAPM model
Use publicly available information to (1) estimate expected rate of return and beta risk
coefficient for any 02 FTSE 100 companies in 02 different industries and (2) estimate risk
(standard deviation) and expected return of the market portfolio.
a) Identify, download and describe required data using publically available sources
including stock price data and other relevant data. You are required to download
relevant data for the 2010-2018 period. Please state the data sources clearly. (10 marks)
b) Use Excel built-in regression or any specialist statistical software such as Stata for the
relevant statistical analysis to (1) estimate the beta risk and the expected return of each
stock and (2) estimate the risk (standard deviation) and the expected return of the
market portfolio. Please interpret the estimated results where relevant. (30 marks)
c) Suppose you want to take 20% risk on your investment portfolio (i.e., the standard
deviation of your investment portfolio is 20%). What is the best expected rate of return
you can get if you invest in the risk-free asset and only one of the chosen stocks? How
much better you can do if you invest in the risk-free asset and both of the chosen stocks?
(20 marks)
d) With reference to the analysis conducted in b), discuss how the CAPM can be used in
practice to assist portfolio investment decisions. (20 marks)
e) With reference to the analysis conducted in c), discuss the practical implications of the
diversification effect. (20 marks)
Sample Solution