Finance Homework – Week 4

I am attaching the questions as an excel file. Each question is on a separate sheet.

2

>CHAPTER

8

– PROBLEM

6

Company:

Chelle Computer

7

2

3

4 8

5 11

6 4 9

		Chapter 8
6.	The following are the historic returns for the	Chelle Computer
Year	General Index
	1			3	1		5
	9		13
–	11	1			4
	-9
		12
Based on this information, compute the following:
				a.	The correlation coefficient between Chelle Computer and the General Index.
					b.	The beta for the Chelle Computer Company

CHAPTER 8 – PROBLEM 8

Chapter 8

and

):

Fund T

%

Fund U

.

0%

b.

8.	As an equity analyst, you have developed the following return forecasts and risk estimates for two
different stock mutual funds (	Fund T	Fund U
Forecasted Return	CAPM Beta
9.	0	1.	20
		10	0.80
a.	If the risk-free rate is 3.9 percent and the expected market risk premium (i.e. E( RM) – RFR)
is 6.1 percent, calculate the expected return for each mutual fund according to the CAPM.
Using the estimated expected returns from Part a along with your own return forecasts,
demonstrate whether Fund T and Fund U are currently priced to fall directly on the
security market line (SML), above the SML or below the SML.
			c.	According to your analysis, are Funds T and U overvlued, undervalued or properly valued?

CHAPTER 8 – PROBLEM 10

Chapter 8

10.

a.

b.

has the following results for the last six periods. Calculate and compare

Rader Tire

(%) (%)

1

12 15

2 12 10 13
3

-9

4

5 20

6

0

c.

Draw the security market line for each of the following conditions:
(1) RFR = 0.08; RM(proxy) – 0.12
(2) Rz = 0.06; RM(true) = 0.	15
	Rader Tire
the betas using each index.
RATES OF RETURN
Proxy Specific Index	True General Index
Period			(%)
29
-12	-8
17	14	18
25	28
-5	-10
If the current period return for the market is 12 percent and for Rader Tire it is 11
percent, are superior results being obtained for either index beta?

CHAPTER 9

– PROBLEM 3

CHAPTER 9

,

, and

. Your preliminary analysis has established the historical risk premiums

), and two variables capturing

and

). These values are:

5%, ƛMACRO1= -0.3%, and ƛMACRO2= 0.6%. You have also estimated the following

MKT MACRO1 MACRO2

QRS

TUV

WXY

0.00

a.

b.

c.

3.	You have been assigned the task of estimating the expected returns for three different stocks:
	QRS	TUV	WXY
associated with three risk factors that could potentially be included in your calculations:
the excess return on a proxy for the market portfolio (	MKT
general macroeconomic exposures (	MACRO1	MACRO2
ƛMKT=	7.
factor betas (i.e. loadings) for all three stocks with respect to each of these potential risk factors:
FACTOR LOADING
Stock
1.24	-0.42		0.00
0.91	0.54	0.23
1.03	-0.09
Calculated expected returns for the three stocks using just the MKT risk factor. Assume
a risk-free rate of 4.5%.
Calculate the expected returns for the three stocks using all three risk factors and the same
4.5% risk-free rate.
Discuss the differences between the expected return estimates from the single-factor model
and those from the multifactor model. Which estimates are most likely to be more useful
in practice?
d.	What sort of exposure might MACRO2 represent? Given the estimated factor betas, is it
really reasonable to consider it a common (i.e. systematic) risk ractor?

CHAPTER 9 – PROBLEM 5

CHAPTER 9

a.

b.

5.	Suppose that three stocks (A, B, and C) and two common risk factors (1 and 2) have the
following relationship:
E( RA)=	(1.1)ƛ1 + (0.8)ƛ2
E( RB)=	(0.7)ƛ1 + (0.6)ƛ2
E( RC)=	(0.3)ƛ1 + (0.4)ƛ2
If ƛ1 = 4% and ƛ2 = 2%, what are the prices expected next year for each of the stocks?
Assume that all three stocks currently sell for $30 and will not pay a dividend in the next
year.
Suppose that you know that next year the prices for Stocks A, B, and C will actually be
$31.50, $35.00, and $30.50. Create and demonstrate a riskless, arbitrage investment to
take advantage of these mispriced securities. What is the profit from your investment?
You may assume that you can use the proceeds from any necessary short sale.

CHAPTER 9 – PROBLEM 7

CHAPTER 9

7. a.

b.

c.

Using regression analysis, calculate the factor betas of each stock associated with each of the
common risk factors. Which of these deviation of the estimated factor correlation coefficients
are stafiscally significant?
How well does the factor model explain the variation in portfolio returns? On what basis can
you make an evaluation of this nature?
Suppose you are now told that the three factors in Exhibit 9.12 represent the risk exposures in
the Fama-French characteristic-based model (i.e., excess market, SMB, and HML). Based on
your regression results which one of these factors is the most likely to be the market factor?
Explaint why.
d.	Suppose it is further revealed that Factor 3 is the HML factor. Which of the two portfolios is
most likely to be a growth-oriented fund and which is the value-oriented fund? Explain why.