Beta Management

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Q1. Calculate the variability (standard deviation) of the stock returns of California REIT and Brown Group during the past 2 years. How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest? The stock returns for each month are given in Table 1. Based on the monthly returns, the standard deviation or variability of each stock has been calculated. The standard deviation for California REIT is 9.23% and the standard deviation for Brown Group is 8.17%. This standard deviation is the monthly standard deviation for each of the stocks. On the other hand the standard deviation of Vanguard Index 500 Trust is 4.61%. This shows that the standard deviation of both the individual
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Q 4. How might the expected return for each stock relate to its riskiness? The expected return for each of the stocks has been calculated by the Capital Asset Pricing Model. The risk free rate is one of the variables used in the CAPM formula. The risk free rate has been assumed here at 7% based on historical statistics as no information has been given regarding it. The second variable is the return on market. This return has been estimated from the average monthly return by transforming it into effective expected annual rate of return. Finally, the third variable used in the CAPM formula is beta which has been calculated in the third question. This beta incorporates the systematic risk in the formula to calculate the expected return for a particular stock. The expected return for Brown Group is 14.87% and for California RIET it is 8.00%. This shows that the expected return for Brown Group is much higher than the expected return of California RIET. The reason for this is that Brown Group stock is much riskier than that of California RIET; therefore, to compensate the high risk, higher return must be paid. When the potential investors will come to invest in the Brown Group stock they will demand extra premium to compensate them for the extra risk they are taking by investing in this stock. This is because of the basic principle of risk and return, which says that higher the risk higher should be the return. Now it will depend on the risk
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