EGP Porto Executive MBA, Finance

Coursework Assignment, Autumn 2006

Dr. Mark Shackleton

DRAFT

Estimating the expected rate of return on a company's stock

You are required to estimate the prospective rate of return on the equity of a company of your choice. This will require an analysis of the historical rates of return on that stock.Chose a firm ad market for which you know you can get stock, index and interest rate data. Notify me by emailonce you and your group have identified a firm (I will maintain a list so that all groups chose a unique firm). The following items are recommended in the final analysis of your firm.

You may wish to describe its principal activities and history as an introduction to your assignment and identify the nature and timing of significant developments in the firm's recent history.

Summarise the current financial accounts (balance sheet) and most recent trading statements (profit/loss and cashflow statement). Estimate the firm's current market value of assets from the sum of the market value of its equity and the book value of its other liabilities. (You may wish to repeat for previous years to examine its evolution).

Construct an equity wealth and a market wealth index, construct monthly holding period returns (or more frequent), calculating the mean and standard deviation of each series. Has your stock over or under performed the market over the period? Which has the higher total risk (s.d. of returns)?

Plot stock returns as a column chart over time and see if you can attribute significant positive (and negative) returns to the timing of release of significant good (and bad) items of news relating to your firm.

Produce two series of excess returns by adjusting each for the monthly cost of borrowing (from the series for the risk free rate) and plot the excess return on equity (Y) against the excess return on the market (X) as an XY scatter graph. Use Excel (regression add in) to estimate the slope and intercept of the best fit line, the standard errors of these estimates and the R2 of the regression.

What is the degree of over/under-performance in your sample and what is the statistical strength of this evidence? What is the stock's sensitivity to market movements and where does it lie on the Security Market Line? What proportion of the stocks variation can be explained by the market variation? Does your data reject the CAPM?

(For all return observations) produce a scatter plot (XY) of this period's excess return (Y) against last period's (X) and test for serial correlation again using regression. What is the slope of the best fit line? If Weak Form Market efficiency is defined as an absence of serial correlation of returns, does your data reject the Weak Form in favour of return predictability?

Chose a prospective market risk premium and use the estimated beta (slope coefficient) from your CAPM regression to calculate a prospective total return from holding your share for a year from now. Find out its current dividend yield and subtract this to estimate the capital gains you could expect over the next year.

Optional: You may or may not, wish to say why the stock may be over or undervalued. If so justify your conclusion.

Word Limit3,000(no more than 12 pages including figures and graphs)

SubmissionDeadline ?