The Stock Market

You have been hired to explain the risk associated with stock market investment. You start with explaining total risk of a security that can be thought of as the sum of two types of risk: systematic risk and unsystematic risk. Systematic risk (market risk) is the kind of risk that cannot be diversified away because it is the risk that tends to affect the entire market in a similar fashion. Then, as an initial project in this area, you also have been assigned the task of creating a presentation that will show the top management team all steps required to measure systematic risk (Beta-β). To begin your work, you open a Web browser and go to http://finance.yahoo.com.

Enter the symbol of the stock of your choice- i.e. NCR, IBM, LU. Find out what the beta of this stock is if it is being released. It can be found under the Key Statistics page under trading information. If you are interested in calculating Beta yourself, then you will:

• Click on Historical data (on the bottom of where you see last trading data.
• Choose monthly data (close price) - for at least 60 periods- at least 5 years.
• Download the data in spreadsheet format and save it in an Excel file.

Then, to collect data for the market - choose an index that measure the volatility of the market, such as DJIA, NASDAQ, or S&P. (Depending on which market the stock is chosen for trading, you may choose different index.)

• Go to yahoo again
• Finance
• Choose an index, DJIA, NASDAQ, etc.
• Historical data
• Choose monthly data-the same period as the one that you choose for the stock
• Download it in spreadsheet format
• Save the data in an Excel file

Now you have two sets of data, one for the market (i.e. DJIA), and the other one is for the stock of your choice (close price).

Use two sets of data; calculate the percentage change in price of your stock and percentage change in market index. Run a regression (dependent variable –Y is the stock, independent variable- X is market changes), make sure to have the intercept checked to zero. You only need the coefficient of X, which is your beta.

Y= βX Coefficient of regression equation is Beta.

After the calculation of beta, answer the following questions:

1. Describe the general approach to valuing a share of stock.
2. Describe what happens to the total risk of a portfolio as the number of securities increases.
3. Suppose a firm’s stock has a beta of 1.2. What will probably happen to the value of the stock if the market decreases by 20 percent?
4. Suppose a firm’s stock has a beta of 0.44. What does that mean?

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