index model_example_sol

# index model_example_sol - 1 What is the expected return of...

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1) What is the expected return of each stock, according to the index model? According to the index model, the expected return of any asset Ri is E(Ri)=ai+bi*E(Rm) We run 5 regressions, one for each stock, to estimate the alpha and the beta of each stock. The expected market return is estimated as the historical average realized market return. It is 0.006 in this sample. E(Target) = 0.005+1.234*0.006 E(Netflix) = 0.001+1.012*0.006 E(HP) = 0.003+0.875*0.006 E(Verizon) = 0.003+0.624*0.006 E(Toyota) = 0.04+0.961*0.006 2) What is the idiosyncratic risk of each stock, according to the index model? The idiosyncratic risk is measured by the standard deviation of the residuals for each regression. This number is reported by Excel and it is called overall standard error of the regression. Idiosyncratic risk (Target) = 0.06 Idiosyncratic risk (Netflix) = 0.06 Idiosyncratic risk (HP) = 0.07 Idiosyncratic risk (Verizon) = 0.06 Idiosyncratic risk (Toyota) = 0.16 3) What is the total risk of each stock, according to the index model? According to the index model, the total variance of any asset Ri is V(Ri)=bi

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## This note was uploaded on 02/06/2012 for the course MGMT 411 taught by Professor Clarke during the Spring '09 term at Purdue.

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index model_example_sol - 1 What is the expected return of...

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