One measure of the risk or volatility of an individual stock is the standard deviation of the total return (capital appreciation plus dividends) over several periods of time. Although the standard deviation is easy to compute, it does not take into account the extent to which the price of a given stock varies as a function of a standard market index, such as the S&P 500. As a result, many financial analysts prefer to use another measure of risk referred to as beta. Betas for individual stocks are determined by simple linear regression.
The dependent variable is the total return for the stock and the independent variable is the total return for the stocks market. Higher the beta of a stock, greater is its market risk. Betas greater than 1 indicate that the stock is more volatile than the market, or that the stock is a volatile investment whose price movements are highly correlated with the market. You are expected to analyse any 5 companies you are interested in – and for some suitable market index. Prepare a report that includes the following items:
a. Compute descriptive statistics for each of the 5 stocks and the suitable market index. Comment on you results. Which stocks are the most volatile? (20 marks)
b. Plot the returns on each stock against returns on index (do as a separate scatter plot for each stock) and compute the correlation between the return on each stock and the return on the market. (10 marks)
c. Compute the value of beta for each stock. Which stocks are the most market risk? Ensure to interpret your results from the regression. (30 marks)
