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Section: B1
Program: BBSNHU
Subject: ECO 402S
Topic: ANALYSING THE CHARACTERISTIC
LINE OF MODERN INVESTMENT
ANALYSIS
Lecturer: Ms Alison Chiu
Date of Submission: 10th March 2020
Introduction
Market model in finance is that the return on a security depends on the return of the
market portfolio and the extent of the security’s responsiveness as measured by beta
(Nasdaq,2020). Capital Asset Pricing Model (CAPM) is one of the market models in finance
commonly used by investors or businesses. It describes the relationship between systematic
risk and expected return for assets and stocks. CAPM is widely used throughout finance for
pricing risky securities and for generating expected returns for assets given the risk of those
assets and cost of capital. It is a better return model as it considers systematic risk, reflecting
a reality which is normally ignored by other models, to calculate the cost of equity. In the
formula of CAPM, the beta refers to the measure of how much risk the investment will add to
the portfolio. If a stock is riskier than a market, it will have a large beta with a value of more
than one. On the other hand, if the stock is less risky than the market, it will have a small beta
with a value of less than one. Moreover, the formula of the market model is given to calculate
the expected return of an asset as a given risk.
A stock’s beta is multiplied by the market risk premium, which is the return expected
from the market above the risk-free rate. The risk-free rate is then added to the stock’s beta
and the market risk premium. The final result will show the required return or discount rate
that provides investors with insight into the value of the asset.
The principle advantage of CAPM is the nature of the estimated cost of equity that
can be generated. This model provides more useful results than any other return models like
DDM and WACC under many situations. CAPM tends to provide more realistic information
and results to investors or businesses with better decision making. While the Weighted
Average Cost of Capital (WACC) is associated with CAPM, it represents its blended costs of
capital across all sources including common shares, preferred shares, and debts. The purpose
of WACC is to determine the capital structure of each part of a company based on the
proportion of equity, debt, and preferred stocks they have. WACC also serves as the discount
rate for calculating the net present value of a business. It is used to evaluate investment
opportunities as well. WACC is important for companies to make their investment decisions
and to evaluate projects with similar and dissimilar risks.
Literature Review
5. Oil Price Volatility and Macroeconomic Factors Influence Stock Market Return:
A Study In Malaysia
Based on the research by Rabia and Khakan (2015), their study is to analyze the
impact of crude oil prices and macroeconomic variables on the stock market of
Malaysia. Data was applied from the year 1981 to 2011, with the application of
Johnson Co. integration, Enterprise Content Management and unit root test. The result
showed a significant association between crude oil prices, macroeconomic variables
on the stock market of Malaysia. Based on the empirical results, it showed that Gross
Domestic Product is significantly affected by the EXP < ROP (Growth rate of oil
price indexed by GDP)and RSP (growth rate of stock price indexed by GDP). It is
discovered that RSP is larger than other variables and it has a crucial role in economic
development. On the other hand, other variables like RSP and ROP are concerned by
the interest rate and exchange rate, which proves that the central bank of Malaysia is
managed steadily by the nature of interest rate.
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to low , & . to low , & . to low , & . to low , & . to low , & . low , & .
No No No No No No
Heteroscedasticity
heteroscedasticity heteroscedasticity heteroscedasticity heteroscedasticity heteroscedasticity heteroscedasticity
No No No No Weak negative No
Autocorrelation
autocorrelation autocorrelation autocorrelation autocorrelation autocorrelation autocorrelation
Findings
The results generated by separately regressing the rate of return on market portfolio
("!" ) on the rate of return on all the six companies’ stocks ("#" ) chosen shows a positive
relationship between the former and the latter. This can be told through the positive
coefficient of the sole independent variable in the model. The tests on the individual
significance and overall significance show that "!" does significantly affect "#" ; however, it
is noticeable that all of the results have a low coefficient of determination ($ $ ), with
0.478814 being the highest among the six $ $ . The low $ $ of all the six companies is an
indication that only a small portion of fluctuations in "#" can be explained by the model,
meaning that this model does not suit the data well. This implies that there are more relevant
independent variables that can be added into this model so that changes in "#" could be better
explained. Besides, the tests on heteroscedasticity of all the six companies’ stock show that
there is no presence of heteroscedasticity in the data. Out of all the six companies, only
Microsoft Corporation’s stocks data show weak negative autocorrelation. We can infer from
the results of regression and tests that under normal circumstances, "#" of any companies is
positively and significantly impacted by "!" with a low $ $ (most likely below 0.50) being
expected when the model in this case is used. Heteroscedasticity is unlikely to present, but
there are chances that autocorrelation is present.
Conclusion
The research to find out the relationship between the rate of return of the market
portfolio and the rate of return of the 6 companies stock shows that there is a positive outcome
to the stock returns when taking market portfolio into account. Thus, it significantly proves
that changes in market portfolio does affect the rate of return of stocks. However, a conduction
of a significance test shows that the while the market model is an explanatory variable that
positively affects stock returns, it also shows that it does not significantly cause changes in
stock returns. This proves that while market model is an effective model, it still does not take
into account other factors that would significantly affect the stock returns. Although stock
market returns provide a great way for you to see how much volatility and what return rates
you can expect over time when investing in the stock market, a proper research and analysis of
historical stock market values would enable investors to find the potentially profitable stock.
A more thorough analysis of the stock price may provide a better result to evaluate the
stock returns. To better evaluate the stock returns flow, one of the models that can be used is
the Fama-French Three factors model as it is an extension of CAPM which means that it is a
better developed model of CAPM. three factors from this model that describe the stock
returns are market risk, the outperformance of small-cap companies relative to large-cap
companies and the outperformance of high book-to-market value companies versus low
book-to-market value companies. This model is having high value and small companies tend
to regularly outperform the overall market. The formula of FF3 model is adding the addition
variables of SMB and HML in the CAPM model to find the expected rate of return. SMB is
the historic excess returns of small-cap companies over large-cap companies. HML is the
historic excess returns of value stocks (high book-to-price ratio) over growth stocks (low
book-to-price ratio). By adding the variables of SMB actually modified stock returns in a
more detailed version. As not most of the public traded companies are in large cap companies
while most of the companies are in small or medium cap companies. Therefore, by just
relying large companies to summarize the overall stock market returns, unable to represent
and forecast a high accuracy expected rate of return (CFI, n.d.).
Appendix
AirAsia Berhad
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
The residuals are randomly scattered around 0 for the entire range of fitted values, indicating
that the model’s predictions are correct on average rather than are systematically too high or
low. In this case, the model is not biased, and the regression result is reliable.
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Performance: The Case of Energy Firms in Vietnam
Rabia, N., & Khakan, N. (2016). Oil Price Volatility and Macroeconomic Factors Influence
Stock Market Return: A Study In Malaysia. Retrieved from
https://www.academia.edu/29707410/Oil_Price_Volatility_and_Macroeconomic_Factors_Inf
luence_Stock_Market_Return_A_Study_In_Malaysia