The Capital Asset Pricing Model

Where:
Re = the return required by investors on a stock

R m
= the average return on the market

R f = the return on risk free investments

 = the stock’s market risk (how sensitive the stock is to
fluctuating in the market )
Calculating the Required Return on
Riyad Bank using CAPM
Data Needed:
1. Share prices of Riyad Bank to calculate the company
return (RRiyadbank )
2. Share prices of Tadawul All Shares Index (TASI)to
calculate the market return ( R m )
3. The return on risk free investments ( R f )

The data in this example were acquired from

Bloomberg
Daily Closing Prices of Riyad Bank
and TASI in 2008
Calculating the Stock Return
Calculating the Market Return
Riyad Bank and TASI Daily Returns
Calculating the Average Market
Return
The Average Market Return
 We simply take the sum of the returns and divide them
by the number of observations.

 TASI average daily return= -0.003 = -0.3%

Calculating Beta Method 1
Calculating Beta Method 1
Calculating Beta Method 1
 Calculating Beta Method 1

However, this method does not tell if β is statically

significant or not.
 Calculating Beta method 2
 You need to make sure you have Excel Add- Ins already
installed. In particular, Analysis Tool Pack.

 You can find Excel Add-Ins in by clicking on file. Then,

at the bottom, choose Excel Add-Ins.

 Then choose Analysis Tool Pack and press ok.

Calculating Beta method 2
Calculating Beta method 2
Calculating Beta method 2
Calculating Beta method 2
 Statistical Significance
 Null Hypothesis ( H ):
0

There is no difference between groups. We assume the null

hypothesis is correct until we have enough evidence to
reject it. Regarding Beta, the stock is not affected by
changes (fluctuations ) in the Market.

 Alternative Hypothesis( H ):
A

There is a difference between groups. Regarding Beta, the

stock is affected by changes (fluctuations ) in the Market.
 Statistical Significance
 The null hypothesis ( ) in this example:
H 0

H : Riyad Bank has no relationship with the market return.

0
Its returns do not get affected by the market fluctuation.

The alternative hypothesis ( H A ) in this example:

H A : Riyad Bank has a relationship with the market.
Its returns fluctuate as the market fluctuates.
 P- Value
We use the P- value to determine if our Beta is statically
significant.
 If P- value < 0.01  is statically significant
at the 99% level (strong).

 If P- value < 0.05  is statically significant at

the 95% level.

 If P- value < 0.1  is statically significant at

the 90% level (weak).
 Beta and the P-Value of Riyad Bank
 β = 0.881 P-Value= 3.77E-45

 P-value< 0.01 β is statically significant at the level 99%.

 We reject the H 0 .

 We are 99% confident that Riyad returns are affected by the market.

 The Coefficient sign is positive Riyad Bank’s returns has a

positive relationship with the market returns. If market return increases,
Riyad Bank’s returns increases and vise versa.

.
 Interpreting Beta
 If R m increase by 1% R
Riyadbank increase by 0.881%

 If R m increase by 2% R riyadbank increase by 1.761 %

R m

(2 X 0.881 %)

 If R m decrease by 5% R riyadbank decrease by 4.403%

(5 X 0.881 %)
 Interpreting Beta
 Beta of the market is always = 1.0
 If the stock beta > 1.0, the stock is more risky than
average
 If stock beta < 1.0, the stock is less risky than average
 Thus, Riyad Bank is less risky than average:
0.8177 < 1.0
 Thus, when the average return on TASI is negative
-0.003, the return on Riyad Bank must be negative
as well. However, lower in magnitude.
Compare Beta with Analysts’
report
Get the Risk Free Return
Get the Risk Free Return
Calculating the Required Return on
Riyad Bank using CAPM
Required Return on Riyad Bank
using CAPM
 Results Interpretation
 The required return on Riyad is in negative because
the market return is in negative. This is because Riyad
Bank is has a positive relationship with the market
returns. However, the decrease is lower in magnitude
because β is lower than 1.0 which means Riyad Bank is
less risky.
 Thanks for Listening

Prepared by:
Rawaa Muhandes
Rawaa_86@hotmail.com