?
⇒ ?
?
= 18%
18% = 3% + ?
?
(14.25% − 3%) ⇒ ?
?
= 1. 3
̅
Alternatively, we could use Asset
A
and the risk-free asset to calculate the slope of the SML, which is equal to
the market risk premium:

351 Test Bank, Page 96 of 140
©2016, Tim Dye.
All rights reserved.
????? = ?(?
?
) − ?
?
=
12 − 3
0.8 − 0
= 11.25%
?(?
?
) = 3 + 1(11.25) = 14.25%
Now use the slope equation with Asset
B
and the risk-free asset to calculate
?
?
:
11.25 =
18 − 3
?
?
− 0
⇒ ?
?
= 1. 3
̅

351 Test Bank, Page 97 of 140
©2016, Tim Dye.
All rights reserved.
62.[X] Considering only assets J, K, U, V, W, X, Y, and Z(ignore Fand M). List in alphabetical orderall assets that are
A.
perfectly correlated to the market (
M
).
U
,
V
B.
overpriced.
K
C.
correctly priced.
U
,
V
,
W
,
X
,
Y
,
Z
D.
?(?
?
) = ?
?
even though
𝜎
?
> 0
.
Why are investors happy with a risk premium of zero even though
W
has a large standard deviation?
All investors hold
M
, so they are not exposed to the unique risk of any individual asset.
Since
?
?
= 0
,
W
has no systematic risk.
E.
Assume the betas of
J
and
K
are correct and that
𝜌
?,?
= 1 3
⁄
and
𝜌
?,?
= 3 4
⁄
.
Clearly show where
J
and
K
will plot on the left-hand chart in equilibrium.
?
?
= 0.5 =
1
3
(
𝜎
?
20
) ⇒ 𝜎
?
= 30%
?
?
= 1.5 =
3
4
(
𝜎
?
20
) ⇒ 𝜎
?
= 40%
40%
30%
20%
10%
0.5
1
1.5
?
𝜎
5%
10%
15%
20%
?(?)
?(?)
In equilibrium,
J
and
K
would both plot on the
SML (right-hand chart) with
?(?
?
) = 10%
and
?(?
?
) = 20%
.
J
K

351 Test Bank, Page 98 of 140
©2016, Tim Dye.
All rights reserved.
Single Index Model
63.
[X]
Bart used 60 monthly returns to fit a security characteristic line for Stock
Q
.
He found
? = 2%
and
? = 1.5.
For the fifth month,
?
?
= −1%
and
?
?
= −4%.
Calculate the residual for this observation.
−4 = 2 + 1.5(−1) + ?
?
⇒ ?
?
= −4.5%
64.
[X]
Page 24 reports selected regression results for stocks
W
,
X
,
Y
, and
Z
.
Answer each of the following
questions and supply a number from the output or a calculation to support your response.
A.
Which stock has the largest alpha?
W
, with
?
?
= 0.686
B.
Which stock has the largest beta?
W
, with
?
?
= 3.799
C.
Which stock has the greatest systematic risk (as a percentage of total risk)?
W
, with
𝜌
?
2
= 0.505
D.
Which stock has the largest residual variance?
What is this stock’s residual variance (calculate it if
necessary)?
Z
, with
𝜎
2
(?
?
) =
677.780
49
= 13.83
, or
???
?
= 14.120
E.
Which stock has the greatest total risk?
How do you know?
Z
has the largest SS Total = 678.194
65.
[X]
The incomplete regression output on page 26 was produced by regressing excess annual returns for
Stock
Q
against excess annual returns for the market index.
Note that the regression used 36
observations, but only five representative observations are reported and graphed.
The return data is
expressed in decimal (not percentage) form.
For example, the predicted return for observation 1 is
–
0.437, or
–
43.7%.
A.
What is the beta of Stock
Q
?
1.745
B.
Stock
Q
’s unique risk is __________% of its total risk.
1 − 0.174 = 82.6%
C.
Calculate Stock
Q
’s unique
risk.
242.319
35
= 6.924
or
??? = 7.127
D.
Calculate the Stock
Q
’s return
for observation 1.
?
?,1
= −0.437 + 0.307 = −0.13
E.
Over the sample period, was Stock
Q
’s return greater than, less than, or equal to its CAPM required
return?
How do you know?
Greater, since
? > 0
.

351 Test Bank, Page 99 of 140
©2016, Tim Dye.
All rights reserved.

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