.
From Exhibit 3:.
Market risk premium = 12.7% - 5.5% = 7.2%.
Computing the CAPM asset beta.
Recall that beta measures the systematic risk of the expected cash flows. If we are measuring the "asset" beta, then we"re measuring the systematic risk of the cash flows associated with real asset.
Think of the firm's balance sheet. The asset beta measures the systematic risk of the left-hand side of the balance sheet. .
Equity and debt are on the right-hand side of the balance sheet. We can also measure the systematic risk of those.
Recall - the balance sheet must balance!.
CAPM asset beta.
The balance sheet requires:.
(rasset) = (D / D+E) * (rdebt) + (E / D+E) * (requity) .
And, by extension, the same relation holds for beta:.
(betaasset) = (D / D+E) * (betadebt) + (E / D+E) * (betaequity) .
Estimating components of asset beta.
Typically, we estimate equity betas from a regression of equity returns on stock market returns.
However, Ameritrade's IPO was in March of 1997. Too close to the timing of this case (August 1997) to use those data.
So, we can look at comparable firms.
We"re recognizing that firms that generate cash flow streams with the same risk will have the same asset beta.
Identifying Comparable Firms.
Exhibit 4 lists 14 firms in three general industries:.
Investment services (A.G. Edwards, Bear Stearns, Lehman Brothers, MSDW, Paine Webber, R. James, Merrill Lynch).
Internet services (Mecklemedia, Netscape, Yahoo).
Discount brokerage (Charles Schwab, E*Trade, Quick & Reilly, Waterhouse Investor Srvcs).
Comparable Firms.
Discount brokers derive most of their revenue from brokerage commissions and net interest revenues.
Sources of income are highly dependent on overall stock market activity.
Full-service firms such as Merrill Lynch have asset management, investment banking and trading in addition to brokerage. Somewhat less correlated with overall stock market.
Ameritrade, though starting Internet service, is not really an Internet firm.
