CAPM the Company I Am Going to Essay

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CAPM

The company I am going to use is Google. According to Yahoo! Finance (2012), the beta for Google is 1.18. This beta means that the company has a greater risk than the market overall (Investopedia, 2012). The market risk is 1.0, so a beta greater than this indicates that the firm's stock is more volatile than the broad market. A beta below 1.0 indicates that the firm's stock is less volatile than the broad market.

The current maturity on one-year Treasuries is 0.18%, according to FRED (2012). If we assume a market risk premium of 6.5%, the cost of equity for Google can be calculated with the capital asset pricing model:

Investopedia (2012) The estimated rate of return for Google using CAPM is 7.85%.

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Two other companies are FedEx and Southwest Airlines. The beta for FedEx is 1.62 and the beta for Southwest is 1.23. If a portfolio is comprised of all three in equal proportions, the beta of the portfolio will be:

(1/3)(1.18) + (1/3)(1.62) + (1/3)(1.23) = 0.393 + 0.54 + 0.41 = 1.343

I do not feel that this three-stock portfolio is significantly diversified. A portfolio that is significantly diversified will have a beta near one, in other words it will track the broad market portfolio closely. In this case, the portfolio is over one-third more volatile than the broad market. All of the securities within the portfolio are fairly volatile. Therefore, the portfolio is not.....

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