Solution Guide to Exercises for Chapter 6 The capital asset pricing model
|
|
- Prudence Bailey
- 7 years ago
- Views:
Transcription
1 THE ECONOMICS OF FINANCIAL MARKETS R. E. BAILEY Solution Guide to Exercises for Chapter 6 The capital asset pricing model 1. The following information is provided for a stock market: µ j β j Asset 1 6.6% 0.4 Asset 2 9.8% 1.2 Asset % 1.8 Notation: µ j = expected rate of return on asset j; β j = beta-coefficient for asset j, j = 1, 2, 3. (a) In the context of the Capital Asset Pricing Model (CAPM), define the beta-coefficient, β j, corresponding to asset j. Discuss how assets beta-coefficients should be interpreted and explain how their values can be obtained in practice. The beta-coefficient can be defined in any of the following equivalent ways: β j = M σ 2 M = ρ jm σ 2 M = ρ jm, where M is the covariance between the rate of return on asset j and the market rate of return, is the standard deviation of the market rate of return, is the standard deviation of the rate of return on asset j, and ρ jm is the correlation coefficient between the rate of return on asset j and the market rate of return. An asset s beta-coefficient is a measure of the relationship between its rate of return and the market rate of return. It can be interpreted as a measure of the asset s risk, relative to the market as a whole. An asset s beta-coefficient is formally the slope co-efficient on the excess rate of return on the market in a regression of the excess rate of return on asset j on the excess rate of return on the market: r j = r 0 + (r M r 0 )β j + ε j, j = 1, 2,..., n, where ε j is an unobserved random error. It is assumed that E[ε j r M ] = 0, that is, the expected value of the error, conditional upon the rate of return on the market portfolio, is zero. Typically (almost always) beta-coefficients are estimated from data on past rates of return (in the regression described above). (b) Assuming that a risk-free asset is available, explain and interpret the Security Market Line (SML) in the context of the CAPM. Construct the SML from the given information and interpret the values of its coefficients. The CAPM predicts that: µ j = r 0 + (µ M r 0 )β j, where µ j is the expected rate of return on asset j, µ M is the expected rate of return on the market portfolio, and r 0 is the risk-free rate of return The SML treats µ j as a function of β j and shows how the expected rate of return on each asset differs according to its beta-coefficient. The slope of the SML is then a measure of the market price of risk. See figure 1. The data in the question must satisfy: = r (µ M r 0 ), and = r (µ M r 0 ).
2 µ j SML µ M r 0 1 β j Figure 1: The Security Market Line, SML Hence it must follow that: µ M = 0.09 and r 0 = Thus, in this example the market price of risk is 4%. Hence the SML is: µ j = β j. (Check that the data for asset 3 also satisfy the SML.) (c) Now suppose a risk-free asset is not available, although the other assumptions of the CAPM remain valid. How should the SML be constructed and interpreted in this case? The formal analysis is the same as for the previous part, except that now the intercept of the SML is interpreted as the expected rate of return on a zero beta portfolio (i.e., a portfolio for which the beta-coefficient is zero). Formally: µ j = ω + (µ M ω)β j, where ω denotes the expected rate of return on a zero beta portfolio. Essentially, the only difference is that the risk-free rate of return is replaced with ω. (Answers should include a brief interpretation of the ω in terms of the Black version of the CAPM check your lecture notes on this.) (d) You are informed that a fourth asset, with β 4 = 0.8, is available. Recent observations reveal that its average rate of return is 7.0%. What inferences, if any, would you draw from this information? [Your answer may be in the context of either (b) or (c), above.] The CAPM predicts that the expected rate of return on the fourth asset is: = But the observed average rate is 7.0% < 8.2%. Hence, the fourth asset is overpriced. This evidence could be indicative either that the market is in disequilibrium or that the CAPM is not a good representation of the market. 2. The following information is provided for a stock market: ρ jm Security A 50% 0.6 Security B 60% 0.2 Market Portfolio 20% 1.0
3 Notation: = standard deviation of the rate of return on asset j = A and j = B; ρ jm = correlation coefficient between the return on asset j and the return on the market portfolio. The mean rate of return on the market portfolio is 8% and the risk-free rate of return is 5%. (a) In the Capital Asset Pricing Model, explain what is meant by the Security Market Line, SML. Calculate the SML from the given information. The Securty Market Line, SML, expresses the relationship between the expected rate of return µ j on assets, or portfolios of assets, and their beta coefficients, β j. Each β j is defined by β j = cov(r j, r M )/var(r M ). In words, the beta coefficient for asset j is the covariance between its rate of return and the market rate of return divided by the variance of the market rate of return. The market rate of return expresses the rate of return on a portfolio in which every asset is represented in proportion to its capital value in the entire market. Thus the beta coefficients are measures of the linear relationship between the rate of return on assets and the rate of return on the market as a whole. Formally, β j can be interpreted as a regression coefficient for the rate of return on asset j as a function of the rate of return on the market portfolio, both being interpreted as rates in excess of a risk-free rate, r 0. The SML in the CAPM can be represented by: µ j = r 0 + (µ M r 0 )β j that is as a straight line with intercept r 0 and slope µ M r 0. From the given information: µ j = ( )β j (1) = β j (2) (b) In the Capital Asset Pricing Model, explain what is meant by the beta coefficient, β j, for a security. Calculate the beta coefficients for the two securities from the given information. As noted above, the β j are defined by: β j = cov(r j, r M )/var(r M ). (See above for an explanation.) From the definition of variances and covariances, it follows that β j = ρ jm / where is the standard deviation of the rate of return on asset j and ρ jm is the correlation coefficient between the rate of return on asset j and the rate of return on the market portfolio. β A = σ A ρ AM = 0.2 β B = σ B ρ BM = = 1.5 (3) = 0.6 (4) (c) You are told that the mean rates of return for securities A and B are 7.5% and 4.6% respectively. What would you infer from this information in the context of the Capital Asset Pricing Model? From the SML, it follows that the predicted rate of return on asset A equals = Given that the observed rate is it follows that asset A is overpriced it is predicted to yield more than is observed. From the SML, it follows that the predicted rate of return on asset B equals = Given that the observed rate is it follows that asset B is underpriced it is predicted to yield less than is observed.
4 Consequently, the evidence suggests that either (i) the markets are in disequilibrium (and offer profitable investment opportunities) or (ii) perhaps the CAPM is not a very good model for these asset markets, or both. 3. What are the main predictions of the Capital Asset Pricing Model (CAPM)? Discuss the role and significance of the assumptions needed to obtain the predictions. Guidance: This is a typical final examination question for which there are many correct answers of varying standards (as well as even more bad answers). What follows are some pointers about how you should set about answering a question like this: (a) Read the question carefully and try to answer it, not just write about the CAPM. This question focuses on the predictions of the CAPM and the underlying assumptions that generate the predictions. (b) Begin by defining the most important terms in the question. Then define the concepts you need. In answering this question, obviously you will concentrate on the CAPM. Describe, briefly, the CAPM in terms of its origins in mean-variance analysis. That is, the CAPM is a model of market equilibrium in which investors choose their portfolios according to a mean-variance criterion and in which they all agree about the means and variances (i.e. homogeneous beliefs). (c) Now you are ready to state the main predictions. These can be summarised according to the three lines : the Capital Market Line, the Characteristic Line and the Security Market Line. Your answer should contain a brief statement of each of these. (Refer to chapter 6 of EFM. Then put EFM aside and then try to write a short paragraph on each.) It would make your answer coherent to tie the predictions together in terms of the equation: µ j r 0 = (µ M r 0 )β j, where β j = ρ jm. In your answer be sure to define what the symbols mean! The Capital Market Line (CML) is such that j denotes an efficient portfolio. The rate of return on any efficient porfolio, say E, is perfectly correlated with the market return. Hence, β E = σ E / and the prediction becomes: µ E r 0 = µ M r 0, σ E which is the equation of the CML. The Characteristic Line, treats µ j r 0 as a function of µ M r 0, with slope β j. This is useful for estimating β j. The Security Market Line treats µ j r 0 as a function of β j, with slope µ M r 0. This is useful for testing the cross-section patterns of asset returns. (d) Next move on to describing the assumptions. While it is not wrong to just give a long list of assumptions, the examiners will be more impressed if you can group the assumptions into catagories and offer some appraisal of their role. (Check chapter 6 of EFM. Then put EFM aside and write a few paragraphs describing the assumptions.) (e) The crucial assumptions are (i) that there is market equilibrium in the sense of a balance between the demand and supply to hold assets, (ii) that all investors choose portfolios according to a mean-variance criterion, and (iii) that they have the same beliefs ( homogeneous or unanimous beliefs) about asset returns. (f) What is the role of these assumptions? The mean variance assumption implies that for each investor: µ j r 0 β j σ Z = µ Z r 0 σ Z or µ j r 0 = (µ Z r 0 )β j, j = 1, 2,..., n,
5 where Z is the efficient portfolio comprising risky assets only. Note that, without further assumptions, µ j, β j and Z could differ from one investor to another. In your answer you should now describe briefly (check EFM, chapter 6, if necessary) why in market equilibrium the portfolio Z can be understood as the market portfolio. Also, the assumption of homogeneous beliefs implies that µ j and β j are the same for each investor. (g) Finally, you could conclude your answer by briefly mentioning the extensions of the CAPM, for example to allow for cases when it is unreasonable to assume that all investors can borrow or lend at a risk-free rate, or to encompass intertemporal planning (Consumption CAPM). Now put EFM and your notes aside and try writing an answer yourself. This will benefit you much more than trying to memorise someone else s answer because in an examination you will almost certainly not be asked to answer this question, instead one based on the same material. While it may help you to memorise definitions, concepts and analysis, learn how to answer questions not to memorise answers! (Rote learning is not rewarded.) *****
Solution: The optimal position for an investor with a coefficient of risk aversion A = 5 in the risky asset is y*:
Problem 1. Consider a risky asset. Suppose the expected rate of return on the risky asset is 15%, the standard deviation of the asset return is 22%, and the risk-free rate is 6%. What is your optimal position
More informationPortfolio Performance Measures
Portfolio Performance Measures Objective: Evaluation of active portfolio management. A performance measure is useful, for example, in ranking the performance of mutual funds. Active portfolio managers
More informationCAPM, Arbitrage, and Linear Factor Models
CAPM, Arbitrage, and Linear Factor Models CAPM, Arbitrage, Linear Factor Models 1/ 41 Introduction We now assume all investors actually choose mean-variance e cient portfolios. By equating these investors
More informationChapter 7 Risk, Return, and the Capital Asset Pricing Model
Chapter 7 Risk, Return, and the Capital Asset Pricing Model MULTIPLE CHOICE 1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky portfolios should she hold
More informationPractice Set #4 and Solutions.
FIN-469 Investments Analysis Professor Michel A. Robe Practice Set #4 and Solutions. What to do with this practice set? To help students prepare for the assignment and the exams, practice sets with solutions
More informationAFM 472. Midterm Examination. Monday Oct. 24, 2011. A. Huang
AFM 472 Midterm Examination Monday Oct. 24, 2011 A. Huang Name: Answer Key Student Number: Section (circle one): 10:00am 1:00pm 2:30pm Instructions: 1. Answer all questions in the space provided. If space
More informationThe Capital Asset Pricing Model (CAPM)
Prof. Alex Shapiro Lecture Notes 9 The Capital Asset Pricing Model (CAPM) I. Readings and Suggested Practice Problems II. III. IV. Introduction: from Assumptions to Implications The Market Portfolio Assumptions
More informationReview for Exam 2. Instructions: Please read carefully
Review for Exam 2 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems You are not responsible for any topics that are not covered in the lecture note
More informationModels of Risk and Return
Models of Risk and Return Aswath Damodaran Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for
More informationCHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM)
CHAPTER 10 RISK AND RETURN: THE CAPITAL ASSET PRICING MODEL (CAPM) Answers to Concepts Review and Critical Thinking Questions 1. Some of the risk in holding any asset is unique to the asset in question.
More informationChapter 5. Conditional CAPM. 5.1 Conditional CAPM: Theory. 5.1.1 Risk According to the CAPM. The CAPM is not a perfect model of expected returns.
Chapter 5 Conditional CAPM 5.1 Conditional CAPM: Theory 5.1.1 Risk According to the CAPM The CAPM is not a perfect model of expected returns. In the 40+ years of its history, many systematic deviations
More informationWEB APPENDIX. Calculating Beta Coefficients. b Beta Rise Run Y 7.1 1 8.92 X 10.0 0.0 16.0 10.0 1.6
WEB APPENDIX 8A Calculating Beta Coefficients The CAPM is an ex ante model, which means that all of the variables represent before-thefact, expected values. In particular, the beta coefficient used in
More informationSAMPLE MID-TERM QUESTIONS
SAMPLE MID-TERM QUESTIONS William L. Silber HOW TO PREPARE FOR THE MID- TERM: 1. Study in a group 2. Review the concept questions in the Before and After book 3. When you review the questions listed below,
More informationThe Tangent or Efficient Portfolio
The Tangent or Efficient Portfolio 1 2 Identifying the Tangent Portfolio Sharpe Ratio: Measures the ratio of reward-to-volatility provided by a portfolio Sharpe Ratio Portfolio Excess Return E[ RP ] r
More informationChapter 11. Topics Covered. Chapter 11 Objectives. Risk, Return, and Capital Budgeting
Chapter 11 Risk, Return, and Capital Budgeting Topics Covered Measuring Market Risk Portfolio Betas Risk and Return CAPM and Expected Return Security Market Line CAPM and Stock Valuation Chapter 11 Objectives
More informationReview for Exam 2. Instructions: Please read carefully
Review for Exam Instructions: Please read carefully The exam will have 1 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions.
More informationM.I.T. Spring 1999 Sloan School of Management 15.415. First Half Summary
M.I.T. Spring 1999 Sloan School of Management 15.415 First Half Summary Present Values Basic Idea: We should discount future cash flows. The appropriate discount rate is the opportunity cost of capital.
More informationThe CAPM (Capital Asset Pricing Model) NPV Dependent on Discount Rate Schedule
The CAPM (Capital Asset Pricing Model) Massachusetts Institute of Technology CAPM Slide 1 of NPV Dependent on Discount Rate Schedule Discussed NPV and time value of money Choice of discount rate influences
More informationLecture 05: Mean-Variance Analysis & Capital Asset Pricing Model (CAPM)
Lecture 05: Mean-Variance Analysis & Capital Asset Pricing Model (CAPM) Prof. Markus K. Brunnermeier Slide 05-1 Overview Simple CAPM with quadratic utility functions (derived from state-price beta model)
More informationFIN 3710. Final (Practice) Exam 05/23/06
FIN 3710 Investment Analysis Spring 2006 Zicklin School of Business Baruch College Professor Rui Yao FIN 3710 Final (Practice) Exam 05/23/06 NAME: (Please print your name here) PLEDGE: (Sign your name
More informationLecture 6: Arbitrage Pricing Theory
Lecture 6: Arbitrage Pricing Theory Investments FIN460-Papanikolaou APT 1/ 48 Overview 1. Introduction 2. Multi-Factor Models 3. The Arbitrage Pricing Theory FIN460-Papanikolaou APT 2/ 48 Introduction
More information1 Capital Asset Pricing Model (CAPM)
Copyright c 2005 by Karl Sigman 1 Capital Asset Pricing Model (CAPM) We now assume an idealized framework for an open market place, where all the risky assets refer to (say) all the tradeable stocks available
More informationChapter 11. Topics Covered. Chapter 11 Objectives. Risk, Return, and Capital Budgeting
Chapter 11 Risk, Return, and Capital Budgeting Topics Covered Measuring Market Risk Portfolio Betas Risk and Return CAPM and Expected Return Security Market Line CAPM and Stock Valuation Chapter 11 Objectives
More informationHolding Period Return. Return, Risk, and Risk Aversion. Percentage Return or Dollar Return? An Example. Percentage Return or Dollar Return? 10% or 10?
Return, Risk, and Risk Aversion Holding Period Return Ending Price - Beginning Price + Intermediate Income Return = Beginning Price R P t+ t+ = Pt + Dt P t An Example You bought IBM stock at $40 last month.
More informationCHAPTER 11: ARBITRAGE PRICING THEORY
CHAPTER 11: ARBITRAGE PRICING THEORY 1. The revised estimate of the expected rate of return on the stock would be the old estimate plus the sum of the products of the unexpected change in each factor times
More informationA Review of Cross Sectional Regression for Financial Data You should already know this material from previous study
A Review of Cross Sectional Regression for Financial Data You should already know this material from previous study But I will offer a review, with a focus on issues which arise in finance 1 TYPES OF FINANCIAL
More informationSimple Regression Theory II 2010 Samuel L. Baker
SIMPLE REGRESSION THEORY II 1 Simple Regression Theory II 2010 Samuel L. Baker Assessing how good the regression equation is likely to be Assignment 1A gets into drawing inferences about how close the
More informationChapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS
Chapter 5 Risk and Return ANSWERS TO SELECTED END-OF-CHAPTER QUESTIONS 5-1 a. Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding only one asset. Risk is
More informationECON4510 Finance Theory Lecture 7
ECON4510 Finance Theory Lecture 7 Diderik Lund Department of Economics University of Oslo 11 March 2015 Diderik Lund, Dept. of Economics, UiO ECON4510 Lecture 7 11 March 2015 1 / 24 Market efficiency Market
More informationCHAPTER 7: OPTIMAL RISKY PORTFOLIOS
CHAPTER 7: OPTIMAL RIKY PORTFOLIO PROLEM ET 1. (a) and (e).. (a) and (c). After real estate is added to the portfolio, there are four asset classes in the portfolio: stocks, bonds, cash and real estate.
More informationChapter 13 Composition of the Market Portfolio 1. Capital markets in Flatland exhibit trade in four securities, the stocks X, Y and Z,
Chapter 13 Composition of the arket Portfolio 1. Capital markets in Flatland exhibit trade in four securities, the stocks X, Y and Z, and a riskless government security. Evaluated at current prices in
More informationCapital Allocation Between The Risky And The Risk- Free Asset. Chapter 7
Capital Allocation Between The Risky And The Risk- Free Asset Chapter 7 Investment Decisions capital allocation decision = choice of proportion to be invested in risk-free versus risky assets asset allocation
More informationCML is the tangent line drawn from the risk free point to the feasible region for risky assets. This line shows the relation between r P and
5. Capital Asset Pricing Model and Factor Models Capital market line (CML) CML is the tangent line drawn from the risk free point to the feasible region for risky assets. This line shows the relation between
More informationChapter 11, Risk and Return
Chapter 11, Risk and Return 1. A portfolio is. A) a group of assets, such as stocks and bonds, held as a collective unit by an investor B) the expected return on a risky asset C) the expected return on
More informationPart 2: Analysis of Relationship Between Two Variables
Part 2: Analysis of Relationship Between Two Variables Linear Regression Linear correlation Significance Tests Multiple regression Linear Regression Y = a X + b Dependent Variable Independent Variable
More informationON THE RISK ADJUSTED DISCOUNT RATE FOR DETERMINING LIFE OFFICE APPRAISAL VALUES BY M. SHERRIS B.A., M.B.A., F.I.A., F.I.A.A. 1.
ON THE RISK ADJUSTED DISCOUNT RATE FOR DETERMINING LIFE OFFICE APPRAISAL VALUES BY M. SHERRIS B.A., M.B.A., F.I.A., F.I.A.A. 1. INTRODUCTION 1.1 A number of papers have been written in recent years that
More informationChapter 10. Key Ideas Correlation, Correlation Coefficient (r),
Chapter 0 Key Ideas Correlation, Correlation Coefficient (r), Section 0-: Overview We have already explored the basics of describing single variable data sets. However, when two quantitative variables
More informationDistinction Between Interest Rates and Returns
Distinction Between Interest Rates and Returns Rate of Return RET = C + P t+1 P t =i c + g P t C where: i c = = current yield P t g = P t+1 P t P t = capital gain Key Facts about Relationship Between Interest
More informationRisk and Return Models: Equity and Debt. Aswath Damodaran 1
Risk and Return Models: Equity and Debt Aswath Damodaran 1 First Principles Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for
More information3.1. Solving linear equations. Introduction. Prerequisites. Learning Outcomes. Learning Style
Solving linear equations 3.1 Introduction Many problems in engineering reduce to the solution of an equation or a set of equations. An equation is a type of mathematical expression which contains one or
More informationElasticity. I. What is Elasticity?
Elasticity I. What is Elasticity? The purpose of this section is to develop some general rules about elasticity, which may them be applied to the four different specific types of elasticity discussed in
More informationChapter 21: The Discounted Utility Model
Chapter 21: The Discounted Utility Model 21.1: Introduction This is an important chapter in that it introduces, and explores the implications of, an empirically relevant utility function representing intertemporal
More informationLecture 3: CAPM in practice
Lecture 3: CAPM in practice Investments FIN460-Papanikolaou CAPM in practice 1/ 59 Overview 1. The Markowitz model and active portfolio management. 2. A Note on Estimating β 3. Using the single-index model
More informationMidterm Exam:Answer Sheet
Econ 497 Barry W. Ickes Spring 2007 Midterm Exam:Answer Sheet 1. (25%) Consider a portfolio, c, comprised of a risk-free and risky asset, with returns given by r f and E(r p ), respectively. Let y be the
More informationFinance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4)
Finance Homework p. 65 (3, 4), p. 66-69 (1, 2, 3, 4, 5, 12, 14), p. 107 (2), p. 109 (3,4) Julian Vu 2-3: Given: Security A Security B r = 7% r = 12% σ (standard deviation) = 35% σ (standard deviation)
More information1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises.
1. Solutions to PS 1: 1. a. (iv) b. (ii) [6.75/(1.34) = 10.2] c. (i) Writing a call entails unlimited potential losses as the stock price rises. 7. The bill has a maturity of one-half year, and an annualized
More informationSimple linear regression
Simple linear regression Introduction Simple linear regression is a statistical method for obtaining a formula to predict values of one variable from another where there is a causal relationship between
More informationCaput Derivatives: October 30, 2003
Caput Derivatives: October 30, 2003 Exam + Answers Total time: 2 hours and 30 minutes. Note 1: You are allowed to use books, course notes, and a calculator. Question 1. [20 points] Consider an investor
More informationModule 3: Correlation and Covariance
Using Statistical Data to Make Decisions Module 3: Correlation and Covariance Tom Ilvento Dr. Mugdim Pašiƒ University of Delaware Sarajevo Graduate School of Business O ften our interest in data analysis
More informationJournal of Exclusive Management Science May 2015 -Vol 4 Issue 5 - ISSN 2277 5684
Journal of Exclusive Management Science May 2015 Vol 4 Issue 5 ISSN 2277 5684 A Study on the Emprical Testing Of Capital Asset Pricing Model on Selected Energy Sector Companies Listed In NSE Abstract *S.A.
More informationSection 14 Simple Linear Regression: Introduction to Least Squares Regression
Slide 1 Section 14 Simple Linear Regression: Introduction to Least Squares Regression There are several different measures of statistical association used for understanding the quantitative relationship
More informationConcepts in Investments Risks and Returns (Relevant to PBE Paper II Management Accounting and Finance)
Concepts in Investments Risks and Returns (Relevant to PBE Paper II Management Accounting and Finance) Mr. Eric Y.W. Leung, CUHK Business School, The Chinese University of Hong Kong In PBE Paper II, students
More informationCorrelation key concepts:
CORRELATION Correlation key concepts: Types of correlation Methods of studying correlation a) Scatter diagram b) Karl pearson s coefficient of correlation c) Spearman s Rank correlation coefficient d)
More informationChapter 27: Taxation. 27.1: Introduction. 27.2: The Two Prices with a Tax. 27.2: The Pre-Tax Position
Chapter 27: Taxation 27.1: Introduction We consider the effect of taxation on some good on the market for that good. We ask the questions: who pays the tax? what effect does it have on the equilibrium
More informationUse the table for the questions 18 and 19 below.
Use the table for the questions 18 and 19 below. The following table summarizes prices of various default-free zero-coupon bonds (expressed as a percentage of face value): Maturity (years) 1 3 4 5 Price
More information17. SIMPLE LINEAR REGRESSION II
17. SIMPLE LINEAR REGRESSION II The Model In linear regression analysis, we assume that the relationship between X and Y is linear. This does not mean, however, that Y can be perfectly predicted from X.
More informationOne Period Binomial Model
FIN-40008 FINANCIAL INSTRUMENTS SPRING 2008 One Period Binomial Model These notes consider the one period binomial model to exactly price an option. We will consider three different methods of pricing
More informationRate of Return. Reading: Veronesi, Chapter 7. Investment over a Holding Period
Rate of Return Reading: Veronesi, Chapter 7 Investment over a Holding Period Consider an investment in any asset over a holding period from time 0 to time T. Suppose the amount invested at time 0 is P
More informationLESSON 28: CAPITAL ASSET PRICING MODEL (CAPM)
LESSON 28: CAPITAL ASSET PRICING MODEL (CAPM) The CAPM was developed to explain how risky securities are priced in market and this was attributed to experts like Sharpe and Lintner. Markowitz theory being
More informationCFA Examination PORTFOLIO MANAGEMENT Page 1 of 6
PORTFOLIO MANAGEMENT A. INTRODUCTION RETURN AS A RANDOM VARIABLE E(R) = the return around which the probability distribution is centered: the expected value or mean of the probability distribution of possible
More informationt = 1 2 3 1. Calculate the implied interest rates and graph the term structure of interest rates. t = 1 2 3 X t = 100 100 100 t = 1 2 3
MØA 155 PROBLEM SET: Summarizing Exercise 1. Present Value [3] You are given the following prices P t today for receiving risk free payments t periods from now. t = 1 2 3 P t = 0.95 0.9 0.85 1. Calculate
More informationc. Given your answer in part (b), what do you anticipate will happen in this market in the long-run?
Perfect Competition Questions Question 1 Suppose there is a perfectly competitive industry where all the firms are identical with identical cost curves. Furthermore, suppose that a representative firm
More informationOn Marginal Effects in Semiparametric Censored Regression Models
On Marginal Effects in Semiparametric Censored Regression Models Bo E. Honoré September 3, 2008 Introduction It is often argued that estimation of semiparametric censored regression models such as the
More information1. Portfolio Returns and Portfolio Risk
Chapter 8 Risk and Return: Capital Market Theory Chapter 8 Contents Learning Objectives 1. Portfolio Returns and Portfolio Risk 1. Calculate the expected rate of return and volatility for a portfolio of
More informationChapter 8 Risk and Return
Chapter 8 Risk and Return LEARNING OBJECTIVES (Slides 8-2 & 8-3) 1. Calculate profits and returns on an investment and convert holding period returns to annual returns. 2. Define risk and explain how uncertainty
More informationUnivariate Regression
Univariate Regression Correlation and Regression The regression line summarizes the linear relationship between 2 variables Correlation coefficient, r, measures strength of relationship: the closer r is
More informationBasic Financial Tools: A Review. 3 n 1 n. PV FV 1 FV 2 FV 3 FV n 1 FV n 1 (1 i)
Chapter 28 Basic Financial Tools: A Review The building blocks of finance include the time value of money, risk and its relationship with rates of return, and stock and bond valuation models. These topics
More informationReview Jeopardy. Blue vs. Orange. Review Jeopardy
Review Jeopardy Blue vs. Orange Review Jeopardy Jeopardy Round Lectures 0-3 Jeopardy Round $200 How could I measure how far apart (i.e. how different) two observations, y 1 and y 2, are from each other?
More informationInvestigating Use of Beta Coefficients for Stock Predictions
University of Akron: Ohio s Polytechnic University IdeaExchange@UAkron Honors Research Projects The Dr. Gary B. and Pamela S. Williams Honors College Spring 2015 Investigating Use of Beta Coefficients
More informationChapter 5. Risk and Return. Copyright 2009 Pearson Prentice Hall. All rights reserved.
Chapter 5 Risk and Return Learning Goals 1. Understand the meaning and fundamentals of risk, return, and risk aversion. 2. Describe procedures for assessing and measuring the risk of a single asset. 3.
More informationOn the Efficiency of Competitive Stock Markets Where Traders Have Diverse Information
Finance 400 A. Penati - G. Pennacchi Notes on On the Efficiency of Competitive Stock Markets Where Traders Have Diverse Information by Sanford Grossman This model shows how the heterogeneous information
More informationExample: Boats and Manatees
Figure 9-6 Example: Boats and Manatees Slide 1 Given the sample data in Table 9-1, find the value of the linear correlation coefficient r, then refer to Table A-6 to determine whether there is a significant
More informationENTREPRENEURIAL FINANCE: Strategy, Valuation, and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy, Valuation, and Deal Structure Chapter 11. The Entrepreneur s Perspective on Value Questions and Problems 1. A venture that requires an investment of $5 million is expected
More informationLesson 5. Risky assets
Lesson 5. Risky assets Prof. Beatriz de Blas May 2006 5. Risky assets 2 Introduction How stock markets serve to allocate risk. Plan of the lesson: 8 >< >: 1. Risk and risk aversion 2. Portfolio risk 3.
More informationMultiple Choice: 2 points each
MID TERM MSF 503 Modeling 1 Name: Answers go here! NEATNESS COUNTS!!! Multiple Choice: 2 points each 1. In Excel, the VLOOKUP function does what? Searches the first row of a range of cells, and then returns
More informationSession 7 Bivariate Data and Analysis
Session 7 Bivariate Data and Analysis Key Terms for This Session Previously Introduced mean standard deviation New in This Session association bivariate analysis contingency table co-variation least squares
More information1 Capital Allocation Between a Risky Portfolio and a Risk-Free Asset
Department of Economics Financial Economics University of California, Berkeley Economics 136 November 9, 2003 Fall 2006 Economics 136: Financial Economics Section Notes for Week 11 1 Capital Allocation
More informationNote: There are fewer problems in the actual Final Exam!
HEC Paris Practice Final Exam Questions Version with Solutions Financial Markets Fall 2013 Note: There are fewer problems in the actual Final Exam! Problem 1. Are the following statements True, False or
More informationChap 3 CAPM, Arbitrage, and Linear Factor Models
Chap 3 CAPM, Arbitrage, and Linear Factor Models 1 Asset Pricing Model a logical extension of portfolio selection theory is to consider the equilibrium asset pricing consequences of investors individually
More informationFinancial Risk Management Exam Sample Questions/Answers
Financial Risk Management Exam Sample Questions/Answers Prepared by Daniel HERLEMONT 1 2 3 4 5 6 Chapter 3 Fundamentals of Statistics FRM-99, Question 4 Random walk assumes that returns from one time period
More informationThe Capital Asset Pricing Model: Some Empirical Tests
The Capital Asset Pricing Model: Some Empirical Tests Fischer Black* Deceased Michael C. Jensen Harvard Business School MJensen@hbs.edu and Myron Scholes Stanford University - Graduate School of Business
More informationChapter 9. The Valuation of Common Stock. 1.The Expected Return (Copied from Unit02, slide 36)
Readings Chapters 9 and 10 Chapter 9. The Valuation of Common Stock 1. The investor s expected return 2. Valuation as the Present Value (PV) of dividends and the growth of dividends 3. The investor s required
More informationENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure
ENTREPRENEURIAL FINANCE: Strategy Valuation and Deal Structure Chapter 9 Valuation Questions and Problems 1. You are considering purchasing shares of DeltaCad Inc. for $40/share. Your analysis of the company
More information2. Linear regression with multiple regressors
2. Linear regression with multiple regressors Aim of this section: Introduction of the multiple regression model OLS estimation in multiple regression Measures-of-fit in multiple regression Assumptions
More informationRisk and Return: Estimating Cost of Capital
Lecture: IX 1 Risk and Return: Estimating Cost o Capital The process: Estimate parameters or the risk-return model. Estimate cost o equity. Estimate cost o capital using capital structure (leverage) inormation.
More informationExamination II. Fixed income valuation and analysis. Economics
Examination II Fixed income valuation and analysis Economics Questions Foundation examination March 2008 FIRST PART: Multiple Choice Questions (48 points) Hereafter you must answer all 12 multiple choice
More informationCHAPTER 6. Topics in Chapter. What are investment returns? Risk, Return, and the Capital Asset Pricing Model
CHAPTER 6 Risk, Return, and the Capital Asset Pricing Model 1 Topics in Chapter Basic return concepts Basic risk concepts Stand-alone risk Portfolio (market) risk Risk and return: CAPM/SML 2 What are investment
More informationHYPOTHESIS TESTING: CONFIDENCE INTERVALS, T-TESTS, ANOVAS, AND REGRESSION
HYPOTHESIS TESTING: CONFIDENCE INTERVALS, T-TESTS, ANOVAS, AND REGRESSION HOD 2990 10 November 2010 Lecture Background This is a lightning speed summary of introductory statistical methods for senior undergraduate
More informationEstimating the NER equity beta based on stock market data a response to the AER draft decision A report for the JIA
Estimating the NER equity beta based on stock market data a response to the AER draft decision A report for the JIA Dr. Tom Hird Professor Bruce D. Grundy January 2009 Table of Contents Executive summary
More informationWhat s New in Econometrics? Lecture 8 Cluster and Stratified Sampling
What s New in Econometrics? Lecture 8 Cluster and Stratified Sampling Jeff Wooldridge NBER Summer Institute, 2007 1. The Linear Model with Cluster Effects 2. Estimation with a Small Number of Groups and
More informationATHENS UNIVERSITY OF ECONOMICS AND BUSINESS
ATHENS UNIVERSITY OF ECONOMICS AND BUSINESS Masters in Business Administration (MBA) Offered by the Departments of: Business Administration & Marketing and Communication PORTFOLIO ANALYSIS AND MANAGEMENT
More informationChapter Seven. Multiple regression An introduction to multiple regression Performing a multiple regression on SPSS
Chapter Seven Multiple regression An introduction to multiple regression Performing a multiple regression on SPSS Section : An introduction to multiple regression WHAT IS MULTIPLE REGRESSION? Multiple
More information1 Portfolio mean and variance
Copyright c 2005 by Karl Sigman Portfolio mean and variance Here we study the performance of a one-period investment X 0 > 0 (dollars) shared among several different assets. Our criterion for measuring
More informationCHAPTER 13 SIMPLE LINEAR REGRESSION. Opening Example. Simple Regression. Linear Regression
Opening Example CHAPTER 13 SIMPLE LINEAR REGREION SIMPLE LINEAR REGREION! Simple Regression! Linear Regression Simple Regression Definition A regression model is a mathematical equation that descries the
More informationModule 5: Multiple Regression Analysis
Using Statistical Data Using to Make Statistical Decisions: Data Multiple to Make Regression Decisions Analysis Page 1 Module 5: Multiple Regression Analysis Tom Ilvento, University of Delaware, College
More informationOverview of Violations of the Basic Assumptions in the Classical Normal Linear Regression Model
Overview of Violations of the Basic Assumptions in the Classical Normal Linear Regression Model 1 September 004 A. Introduction and assumptions The classical normal linear regression model can be written
More informationA Primer on Mathematical Statistics and Univariate Distributions; The Normal Distribution; The GLM with the Normal Distribution
A Primer on Mathematical Statistics and Univariate Distributions; The Normal Distribution; The GLM with the Normal Distribution PSYC 943 (930): Fundamentals of Multivariate Modeling Lecture 4: September
More informationEconomics 1011a: Intermediate Microeconomics
Lecture 12: More Uncertainty Economics 1011a: Intermediate Microeconomics Lecture 12: More on Uncertainty Thursday, October 23, 2008 Last class we introduced choice under uncertainty. Today we will explore
More informationNIKE Case Study Solutions
NIKE Case Study Solutions Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the
More information