Management's Primary Goal Is to Maximize Stockholder Wealth

Evaluating portfolio risk and return

The tendency of a stock's price to move up and down with the market is reflected in its beta coefficient. Therefore, beta is a measure of an investment's market risk, and is a key element of the CAPM.

In this exercise, you get financial information using Yahoo!Finance (found at http://finance.yahoo.com). To find a company's beta, enter the desired stock symbol and request a basic quote. Once you have the basic quote, select the "Key Statistics" option in the "More Info" section of the basic quote screen. Scroll down this page to find the stock's beta. a. Identify the beta listed for a food service (restaurant) company called P.F. Chang’s Bistro, stock symbol PFCB. According to Yahoo!Finance, what is PFCB's beta?

As of this writing on February 23, 2008, the beta for P.F. Chang’s Bistro (PFCB) is −0.02. Because beta calculations are updated as new data is generated constantly, the beta you observe may be different. All remaining numerical results are also valid as of February 23, 2008. b. Again from Yahoo!Finance obtain a report on General Electric (GE) and Ford Motor Company (F). What are the betas listed for these companies?

The beta for General Electric (GE) is 0.63 and the beta for Ford Motor Company (F) is 1.65. c. If you made an equal dollar investment in each stocks what would be the beta of your portfolio?

The portfolio’s beta is the weighted average of its components’ betas. Therefore, this equally-weighted portfolio has a beta of 0.5*0.63 + 0.5*1.65 = 1.14. d. Apply the Capital Asset Pricing Model (CAPM) Security Market Line to estimate the required return on General Electric stock and compare the required return against the return over the last 52 weeks, found in the Yahoo!Finance Profile. Is there a difference between these returns? Is this a problem? Why is there a difference? Assumptions

and Data: Note that you will need an estimate of the risk-free rate, rRF, the market risk premium. Assume a 5% market risk premium and get the current yield on 10-year Treasury securities from Finance!Yahoo’s frontpage- under Investing Tab.choose Bonds.

1 The 10-year T-bond rate is 3.80%. Together with General Electric's beta of .63 and the market risk premium of 5%, we can calculate General Electric's CAPM required return.

rS = rRF + bi(rM -rRF) rS = 3.80% + .63 (5%) rS = 6.95%

Over the last 52 weeks, GE’s return on equity has been 19.72%. Remember that realized returns, expected returns, and required returns are all different measures. In equilibrium, expected and required returns should be equal, but they are both forward-looking, while realized returns are historical.