Estimation Of Capm Fot Miscrosoft And Mobile Exxon

Published Date: 02 Nov 2017

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INTRODUCTION

After the statistical casting the data the data can be applied for the understanding of the underlying financial model which is the capital asset pricing model. This model has some assumptions, which are not the topic of this but the bird eye view of these are the the investor should be rational in taking their decisions and have diversified portfolios for their risk management. Thr risk diversification can be the spreading of the risk to a wide frame of industry such that an expected results in one investment will not cause total unexpected results. The understanding of the risk is that it is not the loss here but the uncertain results which will be seen under as per required

STATISTICAL PLOTTING OF THE MSFT AND XOM DATA AND THEIR RELATIVE FLUCTUATION

The data from XOM and MKT is analysed in this section and the fluctuation has been measured by calculating the standard deviation. The standard deviation of MKT is 0.0484 (Column L in the worksheet) and the standard deviation of XOM is 0.0534 (Column P in the worksheet). As is know that the standard deviation measures for the fluctuations and consequently tells about how consistent is the data with respect to its mean. The more fluctuation shows the more deviation and the less fluctuations means there is less deviation from the mean. The fluctuation are also the measure for the risk as the more fluctuating results will be more risky and the less fluctuating results will be less risky.

(B)

CALCULATION OF THE RISK PREMIUM SERIES AND GIVEN PERIODS AND THE ENTIRE PERIOD

Risk premium here can be explained as the extra extent of risk for which an investor is investing. It is calculated by subtracting the return of market from the risk free returns. Risk free return is the return that is low but they don’t have any type of risk involved, so they make an investment free. Government bonds and securities are the example of the risk free investments and the rate of return, that can be interest or simply the rate of return is usually fixed at a certain point and remains constant. Market return is the unexpected return and hence they are risky. It is important to understand here that risk is not the indication of loss; it is actually the variation from the expected results. The other perspective for the risk premium is that it is an extra compensation that is given to an investor for taking an extra risk, and the investment is defined by the amount of risk, if there is any uncertainty in the return than the investor demands higher rate of return. Risk free returns are not uncertain as compared to the market return and the markets returns are affected by some risks; systematic risk and unsystematic risks. The risks can change the way the return may come to an investors so there are increases chances that the returns may not be as much as the investor is expecting them and in contrast to the market risk free investments are not affected by any risks and the government and other strong stakeholders relevant to that investment give guarantee that this rate will not be uncertain, since it will provide you not a changing returns. It can also be understood that the low risk in the risk-free returns is actually the cost of giving the uncertain results or returns and the same is true for the market return. Risk is the factor which is related with the prospective events and in simple words the future events. It is not easy to predict the future but it is not necessary that these predictions will be right, in the given market.

                                                                         (c)   

DESCRIPTION OF CENTRAL TENDENCY AND DEVIATION

From the given data of the rate of return of the companies Microsoft (MSFT) and Mobil-Exxon (XOM) from January 1998 to December 2008, the return of returns from these companies, for example if the rate of return from Microsoft in Feb. 1998 was 0.08 it means the rate of return was 8 % similarly the other datas in this column are representing the rates of return for the given period.

Mean

The mean for the rate of return for the microsoft is 0.008 or the 0.8 % returns on the investments.

Median

The medain has no special significane here because the data has been slected from the January 1998 to December 2000 with 132 observations. These observation can be obtained according to the requirement for any time period however the median of microsoft is 0.0036 and for XOM it is 0.0033.

Mode

From the company and from January 1998 to December 1998, the rate of return is varying and no return has been the same for the given period so the mode function is not applicable for the given data, unless it is rounded of to the fewer digits which will lose the significance of data. The mode function of the data for XOM is 0 as it was the most repeated value.

Standard Deviation

The standard deviation is showing the fluctuations with respect to the mean of the data, the standard deviation for microsoft is 0.04 wheras the standard deviation for XOM is 0.05 which shows there trends in their respective fluctuation. The fluctuation 0.04 means that it has comparitively less flucutations than the XOM that is 0.05, these flucutations are also showing the risks but the beta shows the the flucutations and the extent of fluctuation too here in these calculations.

Calculations

The mean, median , mode and standard deviation for Microsoft returns is shown in the column I,J,K and L respectively in the and the mean , median, mode and standard deviation for the XOM returns is represented in Cloumn M,N,O and P respectively.

(D)        

ESTIMATION OF CAPM FOT MISCROSOFT AND MOBILE-EXXON

The requisites for the capital asset pricing method are the market rate and the risk free rate which has been given in the supplementary excel worksheets and the beta has also been calculated which shows the extent to which an industry shows the behaviour for the the beta determines the sensibility. Beta is also the covariance here when calculated as the covariance function of an industry return to the market return. For the CAPM, the Risk-free rate of return, the market return and the beta are the main parameters and the required return demanded by an investor depends on that and we can conclude the cost of capital which is the IRR and this is being calculated by multiplying the risk premium to beta and adding the risk free rate which shows the required return by the investor.

Calculations

The calculation for rate required by the investor is calculated by using the capital asset pricing model where the risk free investment is presented in column E , risk premium in column G, the betas for the MSFT and XOM are repesented in column F and H respectively and finally the required rates using the CAPM models have been presented in coulmn Q and S, and their means in column R and T respectively.

Comments

The required rates of returns are being summarized by taking their means so they can be compared with the risk free rates and and the market rate. The average required rate for the microsoft is 3 % and the required rate for the XOM is 3 % calculated wit their respective betas.                                                                                                             

(E)

FINANCE THOERY AND THE INTERCEPT PARAMETER

ASSUMPTION

For the given market, using the finance theory the required rate of return would be zero when the beta would be zero( put beta =0) then these results can be obtained that no changes are being brought about by the risk premium and consequently market has no effect. The more the beta is the more the fluctuation is so on this behalf, if it is supposed that if there the stock is not responsing with the market, it is probable that the stock is not in the market, which excludes the possibilty of relating it to the market.

EXPLANATIONS

Beta is the slope function of the given investment to the market( as mentioned above) if it goes high , the changing of response is more extreme if it low, the changing of the response is low, but if it is negative it shows the inversoe response, so theoritically it could be assumed that there is a point where the given investment does not response with the market and the required return would be just the risk free return. It is incorrect because theoritcally it is right but it works in its limitations. In capital market the risk free premium can not be zero, so this theory may not be true for the values closed to zero or very negligible.

(F)

TESTING THE VARIATIONS WHEN BETA IS 1 AND LESS THAN 1

ASSUMPTION

The beta is suppposed 1 to calulate the responsiveness to its market combined with the risk free rate, and the beta value less than 1 has also been supposed and shown.

CALCULATIONS

The Required rate with beta 1 is presented in column in U and the mean of this in column V and and for less than 1 in column W and the mean in column .

INTERPRETATIONS

The average for the required rate of return when the beta is 1 is 0.2 % and for less than one it’s average is 0.03 and this is showing the required rates of returns at the risk free rate, atlhtough there is a difference but due to the negligibility of beta, it is almost equal to that of the risk free rate.

(G)                                                               

RISK PREMIUM OF MICROSOFT AND XOM AT THE MARKET RISK PREMIUM OF 7%

ASSUMPTION

For the industry wide investments the, the risk changes as the systematic risk changes as it affect the all industries but for the industries of the sam fields often have the results close to each other. We can see that the required rates at the estimated betas are the same for both (shown in column in S and U) so they can have the same beta, if we assumes that they don’t required any adjustments for the debt and Equity component.

ESTIMATION OF THE RISK PREMIUMS

NO change is to be expected if the cost of capital is to be calculated when the risk premium is 7 % for the both companies and the average risk free returns are 3.2 % as shown in column G then the total cost of capital( also the required return) would be 10.2 % and it is also reversable for the recalcutaion of the risk premium for these industries.

(A)

INDUSTRIAL PRODUCTION AND INTEREST RATE FOR SPECIFIC INDUSTRY

DESCRIPTION

Inustrial price Index concludes the market in both favourable and adverse ways for the investors; as this index grows which means this is feasible for the stockholders and if this induction falls this is adverse for the stockholders. It also measures the economic activity and for the risk free investment holders it is feasible when even the this index shows the negative growth.

(A)                                                                                                   

EFFECTS ON THE RISK PREMIUM OF THE GIVEN COMPANIES

The risk premium shows the premium for the investors adjusted for their risk taking initative. In the Capital Asset Pricing Model , the calculation for indutry wide datas is done by any beta available but it has to be degeared and geared for the debt element of the given enterprise so the beta can be taken from the market but needs industry specific adjusments.

(B)

THE RELATION OF INDUSTRIAL PRODUCTION AND INTEREST RATE TO THE RISK PREMIUM OF XOM.

The risk premium for XOM shows the relative investment advantage for the given data and Industrial Price Index shows the relative strenght of economy. What if the investor does the investment and just get the interest form it, which would be safe so why is the need to invest in the industry if the iterest rates are high. The interest rates will be high in case of increased economic activity to slow it down , by the government interventions to avoid the inflations which would be caused by the total increase in the Industrial price Index. The risk premium can be related to it as the risk premium would increase if the interests rate are high to attract an investor because no investor would like to invest in the company if he/she recieves the high interest by investing in the banks or to the creditors.

(C)

SUMMARY

The datas for the given factors are calculated in the work sheets which shows the practical implementations for the given companies as these are the reals datas of the companies rather than the theoritical assumptions. The risk free premium and the interest rates has been analyzed for the sake of calculating the cost of capital or the opportunity cost. The assumptions has also been used to privde the feasbile understanding of the underlying concepts of the financial management and the statiscal analysis for them. The market portfolio has been used and the model used is the Capital asset pricing model and again the understanding for these consepts has been discussed and all the calculations have been included in the worksheet and have been referenced to the worksheet where necessary. The advanced assumptions for the CAPM model has been used and the risk factor has been deeply analyzed over and over again with different perspectives to obtain the different behavours of the same theory.