The following are the historic returns for the Chelle Computer Company:

YEAR CHELLE COMPUTER GENERAL INDEX

1 37 15

2 9 13

3 -11 14

4 8 -9

5 11 12

6 4 9

Based on this information, compute the following:

The correlation coefficient between Chelle Computer and the General Index.

The standard deviation for the company and the index.

The beta for the Chelle Computer Company.

QUESTION 8

As an equity analyst, you have developed the following return forecasts and risk estimates for two different stock mutual funds (Fund T and Fund U):

FORCASTED RETURN CAPM BETA

Fund T 9.0% 1.20

Fund U 10 0.80

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.

According to your analysis, are Funds T and U overvalued, undervalued, or properly valued?

QUESTION 10

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 has the following results for the last six periods. Calculate and compare the betas using each index.

RATES OF RETURN

Period Rader Tire (%) Proxy Specific Index (%) True General Index (%)

1 29 12 15

2 12 10 13

3 -12 -9 -8

4 17 14 18

5 20 25 28

6 -5 -10 0

c.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

QUESTION 3

You have been assigned the task of estimating the expected returns for three different stocks: QRS, TUV, and WXY. Your preliminary analysis has established the historical risk premiums associated with three risk factors that could potentially be included in your calculations: the excess return on a proxy for the market portfolio (MKT), and two variables capturing general macroeconomic exposures (MACRO1 and MACRO2). These values are: λMKT = 7.5%, λMACRO1 = −0.3%, and λMACRO2 = 0.6%. You have also estimated the following factor betas (i.e., loadings) for all three stocks with respect to each of these potential risk factors:

FACTOR LOADING

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