The corporate use of beta

The corporate use of beta - Rosenberg and Rudd The...

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Rosenberg and Rudd “The Corporate Use of Beta” Introduction o The CAPM determines minimum required rates of return from investments in risky assets o CAPM- derived return can be used by corporate managers as the hurdle rates for evaluating corporate investments o Difficulty has been the reasonable judgement about the betas or projects → prices of such non-trading assets are not readily observable and thus the standard statistical estimates of betas cannot be applied The reward for risk-bearing o Investors are concerned with the return on their entire portfolio of assets and the risk of any individual project is relevant insofar as it contributes to the risk of that portfolio o Risk should not be evaluated in isolation, but one must instead consider each project within the context of all other assets → in the company, risk of one division should be compared with the risk of all other divisions o If implementing a project whose returns are very risky but the opposite of the normal cycle → may provide a hedge against the risks of other businesses and reduces risk on an aggregate level o However, even the corporate-wide perspective is not broad enough for most corporations → relevant context is the cumulative portfolio of stockholders o In this context, the appropriate criterion for evaluating risk shifts from the corporate portfolio is the market portfolio The Simple CAPM o Stockholders are assumed to be diversified across many assets and therefore the success or failure of one company is only one contributing factor to the performance of the portfolio o No the isolated equity risk of the individual corporation counts but the contribution to the diversified portfolio
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The corporate use of beta - Rosenberg and Rudd The...

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