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FIN210 Corporate Finance
Case 1: The Beta
In most finance textbooks, you are advised to estimate a stock's beta by running a regression of the stock's returns against the market index's returns. The slope of this regression line represents the beta. However, this method overlooks several crucial questions, including the choice of estimation period as well as the choice the market portfolio. In this case study, you will need to look at the estimation results for a company called Valeant and break down what you get from the regression. What I will give you are the point estimates of beta for Valeant using models with three different market index. You will need to judge the regression results and answer questions relative to the risk of the Company.
Figure 1 Valeant's Betas： Against S&P Pharmaceuticals Index
Figure 2 Valeant's Betas: Against the S&P 500
Figure 3 Valeant's Betas： Against the MSCI Global Index
QUESTIONS:
1. For Valeant, do you find any pattern for the key regression statistics (alpha, beta, and R- squared) from the three regressions? Can you explain the pattern you find?
2. If you were analyzing Valeant and needed to use one of these regression betas, which one would you choose and why? (Hint: You may need the breakdown of Valeant's ownership structure from its annual report or Yahoo Finance to answer this question.)
3. With the chosen beta, estimate the 67% and 95% confidence intervals for the beta and explain what this means for the cost of equity for Valeant.
4. During the regression period, Valeant lost nearly 80% of its market value and faced multiple scandals and management turnover. Would this crisis affect your estimation results? If yes, what would be the beta effect of this crisis (increased, decreased, or unchanged)? Explain your answer.