Ch 10 revised

Ch 10 revised - CHAPTER 10: INDEX MODELS 3. a. The two...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
CHAPTER 10: INDEX MODELS 3. a. The two figures depict the stocks’ security characteristic lines (SCL). Stock A has a higher firm-specific risk because the deviations of the observations from the SCL are larger for Stock A than for Stock B. Deviations are measured by the vertical distance of each observation from the SCL. b. Beta is the slope of the SCL, which is the measure of systematic risk. The SCL for Stock B is steeper; hence Stock B’s systematic risk is greater. b. The R 2 (or squared correlation coefficient) of the SCL is the ratio of the explained variance of the stock’s return to total variance, and the total variance is the sum of the explained variance plus the unexplained variance (the stock’s residual variance). ) i 2 2 M 2 i 2 M 2 i 2 e ( R σ + σ β σ β = Since the explained variance for Stock B is greater than for Stock A (the explained variance is 2 M 2 B σ β , which is greater since its beta is higher), and its residual variance σ 2 (e B ) is smaller, its R 2 is higher than Stock A’s.
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 11/02/2011 for the course FIN 300 taught by Professor Staff during the Summer '08 term at Ill. Chicago.

Page1 / 3

Ch 10 revised - CHAPTER 10: INDEX MODELS 3. a. The two...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online