- The beta estimates are reasonable. The beta coefficients of all the assets are less than one which, when compared to the market beta of one indicates that the price of the investment will be less volatile than the market. This is due to the fact that the betas of these investments are less than the market value which is taken as the benchmark value.
- The most important measure of risk in this situation is the calculation of Sharpe ratio. This is because this ratio measures the risk adjustment performance of the investment as opposed to standard deviation which just measures the deviation from the mean and the beta coefficient which measures the level of systematic risk and compares it to the whole market. The Sharpe ratio measures the risk that is associated with the performance of a stock.
- These calculations are based on historical data. This may present a problem due to the fact that the market conditions change frequently over time and the value of money changes with time. This means that these calculations become invalid within a very short period of time as the market is changing continuously. This problem is solved by pricing of the investments using the Capital Asset Pricing Model which incorporates risk and the time value of money.
- Large cap stocks are the most risky of them all due to the fact that this group has the highest value of systematic risk. This means that its market is the most volatile among the three. This is followed by the small cap stocks which have a lower systematic risk than the large cap but its risk is higher than the mid cap. The mid cap is the least risky since it has the lowest value of systematic risk.
- The historical men return of each stock has great disparities when compared to the standard measure of risk. However, when the Capital Asset Pricing Model is used in the calculation of these returns, the disparities become smaller. This is due to the fact that CAPM incorporates the aspect of risk that is created by the passage of time, which was not considered in the calculation of the historical average. This means that the values got from the historical average of the returns were just abstract and they did not capture the continuous changing of the market condition. They therefore did not capture the aspect of risk.
- The Capital Asset Pricing Model is one of the best measures of measuring the level of expected returns of different projects. This is due to the fact that unlike the Dividend Discount Model and the Residual Income Model which solely concentrate on the returns in different forms, CAPM incorporates the aspect of risk and time value of money. (Cannot make conclusions since I do not have the previous projects.)
- The three standard measures of performance of the stocks were inconsistent across the three methods. When using Treynor ratio and Jensen’s alpha, the HLX were found to be the best performing stocks. However, when using the Sharpe ratio, the COF were the best performing stocks. In my opinion, the HLX stocks are the best performing since they were chosen using the market security line and also the excess return it generates over the expected return. This has been demonstrated by the Treynor ratio and Jensen’s alpha methods of performance evaluation.
