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Monday, December 5, 2011

calculate the risk free rate of return on stock

calculate the risk free rate of return on stock : In finance, rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost (whether realized or unrealized) on an investment relative to the amount of money invested. The amount of money gained or lost may be referred to as interest, profit/loss, gain/loss, or net income/loss. The money invested may be referred to as the asset, capital, principal, or the cost basis of the investment. ROI is usually expressed as a percentage.

The other posters who are familiar with CAP-M are correct. The proxy for the risk free rate of return are US Treasuries. You can find the rates of return for Treasuries on either yahoo finance or google finance.

You may also notice that betas tend to differ slightly - it depends on whether they're historical, forward looking, based on consensus, etc. You can also find the rate of return on the market (use the S&P Index) at either google finance or yahoo finance.

Here's part of an article on the Capital Asset Pricing Model from Investopedia.com:

Here is the formula:

rj = rf + b(rm-rf)
where:
rj= expected return on asset j
rf= ten year US Treasury rate (the "risk free" rate)
b= beta
rm=market return


CAPM's starting point is the risk-free rate - typically a 10-year government bond yield. To this is added a premium that equity investors demand to compensate them for the extra risk they accept. This equity market premium consists of the expected return from the market as a whole less the risk-free rate of return. The equity risk premium is multiplied by a coefficient that Sharpe called "beta".

Beta
According to CAPM, beta is the only relevant measure of a stock's risk. It measures a stock's relative volatility - that is, it shows how much the price of a particular stock jumps up and down compared with how much the stock market as a whole jumps up and down. If a share price moves exactly in line with the market, then the stock's beta is 1. A stock with a beta of 1.5 would rise by 15% if the market rose by 10%, and fall by 15% if the market fell by 10%. (For further reading, see Beta: Gauging Price Fluctuations and Beta: Know The Risk.)

Beta is found by statistical analysis of individual, daily share price returns, in comparison with the market's daily returns over precisely the same period. In their classic 1972 study titled "The Capital Asset Pricing Model: Some Empirical Tests", financial economists Fischer Black, Michael C. Jensen and Myron Scholes confirmed a linear relationship between the financial returns of stock portfolios and their betas. They studied the price movements of the stocks on the New York Stock Exchange between 1931 and 1965. For the latest updates on the stock market, visit Stock Market Today For the latest updates PRESS CTR + D or visit Stock Market news Today

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