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Introduction to Dow Jones 30 Index

Questions:

1.Provide a Brief Discussion on the Chosen Index

2.Provide the latest and relevant Contribution of the Stock

3.Provide the aggressive and defensive securities within the Chosen Index

4.Discuss on Securities, which are Undervalued and Overvalued:

5.Recommend the Adequate Investment on the Financial Evaluation.

The overall Dow Jones 30 Index is mainly selected due to the high liquidity in the market. In addition, the index holds the maximum number of shares all around the world and represent the exact trend of the world. The index mainly comprises of significant stocks traded in NYSE and NASDAQ. The index is one of the oldest in world and effectively watched by maximum of the investors around the world. Dow Jones 30 Index mainly comprises of high yielding stocks, which are used by investors to identify the current trend of the market.

The overall stock selected in the assignment mainly depicts the CAPM return, Beta and Alpha, which could help in pinpointing the adequate stock for investment. The use of Security Market Line diagram could depict the adequate overvalued and undervalued stocks. Dionne, Li and Okou (2013) mentioned that SML line is an effective method to pin point viable investment opportunity, which could increase return from investment. However, Dzaja and Aljinovic (2013) argued that SML line is solely dependent on CAPM, which increase the risk of investment drastically for investors. The derivation is aggressive and defensive stock could only be detected by evaluating its alpha and beta, which is used by investors during their investment decision period.

Journals Used in CAPM

Contribution

Ahmed, M. and Chowdhury, F., 2016. Understanding Risk-Return Relationships: Using the Capital Asset Pricing Model to Evaluate Securities of the Food and Allied Sector in Bangladesh. Imperial Journal of Interdisciplinary Research, 2(4).

The contribution of the journal is towards identifying the impact of CAPM in determining the stocks overvalue or under value scenario.  

Shoaib, A. and Siddiqui, M.A., 2016, October. Quantile Methods for Testing the Applicability of CAPM and FF-Model in Pakistan. In GAI International Academic Conferences Proceedings (p. 78).

The journal mainly helped in identifying the impact to CAPM method in using the Quantile regression method. The finding mainly stated that the FF model is more adequate and contributes more value to the analysis than the CAPM model. 

Sembiring, F.M., Rahman, S., Effendi, N. and Sudarsono, R., 2016. Capital asset pricing model in market overreaction conditions: evidence from Indonesia Stock Exchange. Polish Journal of Management Studies, 14(2), pp.182-191.

The journal mainly uses the CAPM model in detecting the price movement of a share. Moreover, the CAPM models could help in identifying the impact it has on returns of a share.

Lee, H.S., Cheng, F.F. and Chong, S.C., 2016. Markowitz Portfolio Theory and Capital Asset Pricing Model for Kuala Lumpur Stock Exchange: A Case Revisited. International Journal of Economics and Financial Issues, 6(3S).

The study mainly depicts whether CAPM model is adequate in determining the forecasted value of a stock.

Gómez-González, J.E. and Sanabria-Buenaventura, E.M., 2014. Non-parametric and semi-parametric asset pricing: An application to the Colombian stock exchange. Economic Systems, 38(2), pp.261-268.

The journal mainly aims in identifying the non parametrical CAPM, which could be used in rejecting the classical liner CAPM.

Chakraborty, I., Kumar, A., Muhlhofer, T. and Sastry, R., 2016. CAPM, Factors, and Sectors: Do Investors Utilize Available Information?.

The journal mainly determines whether the allocation of investors is best predicated by CAPM or not.

Dai, J., Hu, J. and Lan, S., 2014. The empirical research of application of CAPM in China market. BioTechnology: An Indian Journal, 10(12).

The papers mainly validates the overall impact of CAPM in Chinese stock market

Alqisie, A. and Alqurran, T., 2016. Validity of Capital Assets Pricing Model (CAPM)(Empirical Evidences from Amman Stock Exchange). Journal of Management Research, 8(1), pp.207-223.

This journal mainly evaluates the impact of CAPM model in different time zones, like monthly, weekly and daily. 

Michaud, R., Michaud, R. and Balter, D., 2013. fi360 Asset Allocation Optimizer: Risk-Return Estimates. Boston: New Frontier Advisors LLC. www. flexscore. com/ui/content/CapitalMarketInputs. pdf.

The journal mainly utilises the CAPM models in determining the mean variance and effective it has on the overall optimal portfolio.

Fan, G., Girardin, E., Wong, W.K. and Zeng, Y., 2015. The Risk of Individual Stocks’ Tail Dependence with the Market and Its Effect on Stock Returns. Discrete Dynamics in Nature and Society, 2015.

The journal mainly states that CAPM mainly depicts the friction when investors use short selling measures as an investment option.

Particulars

CAPM return

Beta

Alpha

Southern Missouri Bancorp, Inc. 

-2.23%

             (0.35)

5.53%

Greene County Bancorp, Inc

-0.95%

             (0.25)

5.43%

Prudential Bancorp, Inc

1.70%

             (0.04)

2.94%

Risk free return

2.25%

0

0

Malvern Bancorp, Inc

3.44%

               0.09

2.09%

Wellesley Bancorp, Inc.

4.00%

               0.14

-0.32%

United Community Financial Corp

4.78%

               0.20

0.24%

Home Bancorp, Inc

7.48%

               0.41

-3.47%

New York Community Bancorp, Inc

7.77%

               0.43

-7.56%

Heritage Financial Corporation

8.95%

               0.52

-6.09%

Timberland Bancorp, Inc

10.18%

               0.62

-5.78%

FS Bancorp, Inc

10.43%

               0.63

-5.14%

Berkshire Hills Bancorp, Inc.

10.47%

               0.64

-8.69%

WVS Financial Corp

10.93%

               0.67

-8.49%

First Connecticut Bancorp, Inc

11.10%

               0.69

-7.95%

United Financial Bancorp, Inc

13.66%

               0.89

-11.68%

Market return

15.14%

               1.00

0

Table 1: Depicting the Beta, Alpha and CAPM returns

(Source: As created by the author)

The above table mainly depicts the relevant aggressive and defensive stocks listed in Dow Jones 30 Index. Out of the 15 stock, whose beta is less than zero could be considered as the defensive stock, which are used by investors if stock market does not perform well or is in a down trend. There are three stocks namely Southern Missouri Bancorp, Greene County Bancorp, and Prudential Bancorp, which could be identified within the 15 stocks as the defensive investment opportunity. The rest of all the 12 stocks listed in the table 1 could be identified as the aggressive stock, which is used by investors to increase return from their investment. These aggressive stocks mainly have a positive beta, which increase the chance of loss for the investor. Dzaja and Aljinovic (2013) mentioned that investors mainly use the defence stocks as hedging instruments because it helps in reducing the losses incurred in aggressive stocks. However, Ha and Hoang (2017) argued that hedging strategies mainly loses its friction if the whole capital market is experiencing a recession.


The above table also depicts the alpha and beta of the stocks chosen from the Dow Index 30. The derivation beta and Alpha mainly allows the investor to understand them minimum risk, which is needed by them to maintain the position in the capital market. Habibi, Habibi and Habibi (2016) mentioned the beta derivation is an essential part of CAPM valuation, as higher beta will mainly increase the expected return generated from an investment.

Application of CAPM Return, Beta, and Alpha

Table 1, also depicts the overall return from investment on each of the 15 stocks, which could be used by investors to locate the adequate investment opportunity. The overall CAPM returns mainly depict the beta of each stock. According to the CAPM model higher beta measures high return, this is expected from a stock. Jagric et al. (2015) stated that non-fulfilments of the expected return could eventually instigate a large sell sphere, which could decline share price of the stock.

Figure 1: Depicting the Security Market Line comprising of 15 stocks

(Source: As depicted by the author)

The figure mainly depicts the relevant stock, which have the adequate return and could be efficiently be used as an investment option. CAPM return mainly provides all the relevant stocks, which could be used as the viable option by shareholders for generating return from investment. The overall SML line mainly depicts the over and undervalued stocks, which could provide retune from investment to the investor. There are no under over valued stocks, as the CAPM of all the stock is on the trend line of risk free rate. This only indicates that with higher beta returns could be changed from investment. Thus, it could be understood that there is no under or overvalued stocks present in the 15 stocks. Lipiec (2014) stated that the use of CAPM mainly allows investor to identify the most viable stock, which could provide adequate return from investment. On the other hand, Mazzola and Gerace (2015) criticises that SML derivations could mainly reduce its friction if adequate CAPM return are not derived from calculations.

Particulars

CAPM return

Beta

Alpha

Malvern Bancorp, Inc

3.44%

               0.09

2.09%

Wellesley Bancorp, Inc.

4.00%

               0.14

-0.32%

United Community Financial Corp

4.78%

               0.20

0.24%

Home Bancorp, Inc

7.48%

               0.41

-3.47%

New York Community Bancorp, Inc

7.77%

               0.43

-7.56%

Heritage Financial Corporation

8.95%

               0.52

-6.09%

Timberland Bancorp, Inc

10.18%

               0.62

-5.78%

FS Bancorp, Inc

10.43%

               0.63

-5.14%

Berkshire Hills Bancorp, Inc.

10.47%

               0.64

-8.69%

WVS Financial Corp

10.93%

               0.67

-8.49%

Table 2: Depicting the stock for investment

(Source: As created by author)

The above table mainly depict the list of stock, which have the least beta and could provide higher return from investment. The returns are mainly within the market return and are comprised of low beta. Investment in the above-depicted stocks could eventually help the investors in generating a constant income from investment, as the risk of investment is relatively low (Nghiem 2015). Thus, the investors for generating a steady return from investment could conduct investment in the above stocks.

Reference

Dionne, G., Li, J. and Okou, C., 2013. An Extension of the Consuption-Based CAPM Model.

Dzaja, J. and Aljinovic, Z., 2013. Testing CAPM model on the emerging markets of the Central and Southeastern Europe. Croatian Operational Research Review, 4, p.164.

Džaja, J. and Aljinovi?, Z., 2013. Testing CAPM model on the emerging markets of the Central and Southeastern Europe. Croatian Operational Research Review, 4(1), pp.164-175.

Ha, N.M. and Hoang, N.D., 2017. Applying the CAPM Model in Identifying the Electricity Retail Price in Ho Chi Minh City, Vietnam. International Journal of Energy Economics and Policy, 7(2), pp.185-192.

Habibi, H., Habibi, R. and Habibi, H., 2016. Derivation of Kalman Filter Estimates Using Bayesian Theory: Application in Time Varying Beta CAPM Model. Journal of Statistical and Econometric Methods, 5(2), pp.1-16.

Jagric, T., Podobnik, B., Strasek, S. and Jagric, V., 2015. Risk-adjusted performance of mutual funds: some tests. South-eastern Europe journal of Economics, 5(2).

Lipiec, J., 2014. Capital Asset Pricing Model Testing at Warsaw Stock Exchange: Are Family Businesses the Remedy for Economic Recessions?. International Journal of Financial Studies, 2(3), pp.266-279.

Mazzola, P. and Gerace, D., 2015. A Comparison Between a Dynamic and Static Approach to Asset Management Using CAPM Models on the Australian Securities Market. Australasian Accounting Business & Finance Journal, 9(2), p.43.

Nghiem, L., 2015. Risk-return relationship: An empirical study of different statistical methods for estimating the Capital Asset Pricing Models (CAPM) and the Fama-French model for large cap stocks. arXiv preprint arXiv:1511.07101.

Sharifi, M., Ohadi, F. and Monjazeb, M.R., 2014. The Relationship between Stock Risk and Return Using the Consumption Based Capital Asset Pricing Model (C-CAPM) in the Food and Pharmaceutical Industries. Asian Journal of Research in Banking and Finance, 4(5), pp.90-103.

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