Analysis Of Austar

Executive Summary

This report focuses on applying CAPM model to analyze the performance of a stock issued by Austar United Communications Limited (AUN). It includes the following six major parts:

 Introduction of AUN

 Beta estimation

 Alternative beta adjustment techniques

 Calculation of abnormal return

 Share price fluctuations and events

 Conclusion and recommendation

1. Introduction

AUSTAR United Communications Limited (AUN) is a provider of subscription television services in Australia, mainly providing satellite delivered services to regional and rural via a satellite distribution platform owned by AUN and Optus. The core business of AUN is TV service, and it also offers mobile telephone and Internet services. In addition, AUN operates a wireless cable network, which was established in 2000 and is now available nationally. (http://www.aspecthuntley.com.au.)

2. Beta estimation

2.1. The importance of beta estimation

The capital asset pricing model (CAPM) was formed on the basis of Professor Harry Markowitz's basic theory of portfolio choice. This model can be used by investors to determine the expected return on any security. The equation is:

E(Ri,) = Rf +β* E(Rm-Rf,)

Where E(Ri,) = the expected return on security i

E(Rm) = the expected return on the market

Rf, = the risk-free rate of return

β = the beta of security i

As the CAPM reveals, in order to apply the model to determine the expected return of a stock, the estimation of beta is necessary.

2.2. Calculation of beta

Beta is the expected relationship between returns on a stock and returns on the market, the beta of a stock can be estimated by quantifying the historical relationship between price movements on the stock and price movements on the market as a whole (Frion & Chen,2006). Beta can be estimated by Capital Asset Model (CAPM) as:

Where， = the expected return on security i.

= the expected return on the market.

= the return on the risk free asset.

According to this equation, the following issues should be considered when estimating beta.

2.2.1. Time period

Time period has a significant impact on the value of beta. The more relevant the time period is to the market and company situation of a particular year, the more accurate the data is. Moreover, as Daves et al. (2000) stated, a longer estimation period could result in a higher likelihood that there will be a significant change in the value of beta due to underlying changes in the management or organization of the company. These arguments indicate that beta calculations estimated over longer time periods are more likely to be biased and therefore of less value to investors. Consequently, in this case, the data is selected from June 2005 to June 2007, and this choice is comply with the rule of choosing observing period.

2.2.2. Sample frequency

Regarding to sample frequency, in 2003, Attila Odabasi measured the effect of the estimation period on beta estimates of individual stocks through computing correlation coefficients over pairs of adjacent estimation periods. According to his research, betas over the two year estimation period seem to be more stable when working with weekly return data. Therefore, in this case, two year weekly data has been selected.

2.2.3. Variation

Based on the CAPM theory, in order to calculate the Beta of an individual stock, a proxy for the market portfolio and a proxy for risk free rate of return are required.

A risk free asset refers to an asset in which the actual return is equal to the expected return, which means that there is no variance around the expected return (Frino A., et al, 2006). In practice, the risk free asset does not exist. However, according to Bowman (2001), 10 year government bond represents a low risk investment because this kind of return is normally guaranteed by government in substance. So that, in this case, 10 year government bond is chosen as an index of risk-free return.

Market portfolio is a portfolio that contains all stocks that are available to investors (Alex and Chen, 2004). This kind of portfolio cannot be formed in practice, so that All Ordinary Accumulation Index (AOAI) is commonly used as the market index since it represents the major large capitalization index.

2.3. β estimation of AUN

According to the formula of CAPM, beta can be described as the covariance of excess returns on the stock and on the market, divided by the variance of the latter one, where the excess returns equal to the value of the stock or the market return over an appropriate risk free rate of return (Frino, 2006).

Applying the CAPM approach, (details can be seen in the appendix).

the β value of AUN is: βAUN=0.6324671287

Since β indicates the correlativity of the individual stock risk to the market risk, AUN, with the β being lower than 1, is much less risky than the overall market. The estimation of β equals to 0.6325(round to 4 decimal places), which indicates that every 10% change in market return will cause a change by 6.325% of AUN stock return.

3. Alternative beta adjustment techniques

There are numerous studies concerned with the theoretical and empirical examination of beta estimation.

3.1. Dimson Beta estimation (1979)

Dimson's method is a development of the lagged market return approach. It requires neither the market index to be continuously traded nor supplementary data, such as transactions information to be available.