KIC000026 - An Example The Security Market Line Estimate...

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An Example • Estimate IBM's expected return using this information you obtained from the web: 3-month T-bill rate 30 year bond rate AM Corporate Bond S&P500 annual return IBM beta 4.98% 6.85% 8.87% 12.91% 0.5 • Riskfree rate is 4.98%, expected return on the market is 12.91%, IBM beta is 0.5 E{RIBM) = 4.98+[1291-4.98].0.5 E(R 1BM ) = 4.98+ 7.93x0.5 = 8.945% Beta of a Portfolio of Assets • The beta of a portfolio of assets is the weighted average of the individual betas. where the weights must sum to one. How to Estimate Beta • We estimate beta using Ordinary Least Squares regression of the cAPM equation, where returns are expressed in excess return form: R, == R f + fJitR M -R f )+ei (R;-R f )== fJi(RM-Rf)+e j y == f3X +e i • where e, is an error term which reflects firm-specific risk not being captured by beta. • Note: The R2 of the regression gives the percent of total variance that is attributable to systematic risk. The Security Market Line Expected Return Security Market Line E(Market Return) 42 Overpriced Securities Risk-free Return Portfolio Beta Example
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