Analysis of the Bond’s Risk and Return Relationship with the Use of the Capital Asset Pricing Model

In this master's work there were tested hypotheses on the applicability of the CAPM-model to assess the bond yield. The beta coefficient was calculated in three ways: by the covariance of returns with the stock market, by the covariance of returns with the bonds market and by the ratio of the bond’ duration to the duration of the market bonds’ index. For each method, security market line was built. During testing of hypotheses, it was made a conclusion about the inapplicability of the CAPM model for the estimation of bond yields. However, the calculation of the beta coefficient by the third method showed a behavioral effect, showing that investors under-estimate the risk of investment grade bonds and over-estimate the risk of speculative grade bonds. Further study of this effect in the dynamics showed that indeed during the whole period, real returns on speculative bonds are higher than the theoretical, calculated according to the model CAPM, and investment, respectively, below the theoretical. Moreover, «the width of the corridor» between the actual and theoretical yields varies depending on the rating of the bonds. According to available data, we calculated the premium for credit risk for each rating category, which is a kind of premium for the rating (negative for investment grade bonds and positive for speculative grade bonds). The obtained data formed the basis of the modified CAPM model, which in turn was tested on a sample of bonds, and has shown greater efficiency compared to the traditional CAPM. The theoretical return calculated for the new CAPM, in 76% of cases is "closer" to the actual yields of the bonds. Thus, we can conclude that the modification of the CAPM model by including the premium for credit risk allows improving the accuracy of estimates of bonds’ yields.