Using Past Information to Estimate Required Returns

Use online resources to work on this chapter's questions. Please note that website information changes over time, and these changes may limit your ability to answer some of these questions.

Chapter 8 discussed the basic trade-off between risk and return In the capital asset pricing model (CAPM) discussion, beta was identified as the correct measure of risk for diversified shareholders. Recall that beta measures the extent to which the returns of a given stock move with the stock market. When using the CAPM to estimate required returns, we would like to know how the stock will move with the market in the future, but because we don’t have a crystal ball, we generally use historical data to estimate this relationship with beta.

As mentioned in Web Appendix 8A, beta can be estimated by regressing the individual stock's returns against the returns of the overall market. As an alternative to running our own regressions, we can rely on reported betas from a variety of sources. These published sources make it easy for us to readily obtain beta estimates for most large publicly traded corporations. However, a word of caution is in order. Beta estimates can often be quite sensitive to the time period in which the data are estimated, the market index used, and the frequency of the data used. Therefore, it is not uncommon to find a wide range of beta estimates among the various Internet websites.

3. Now let's take a closer look at the stocks of four companies: Colgate Palmolive (Ticker - CL), Campbell Soup (CPB), Motorola Solutions (MSI), and Tiffany k Co (T1F). Before looking at the data, which of these companies would you expect to have a relatively high beta (greater than 1.0) and which of these companies would you expect to have a relatively low beta (less than 1.0)?

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