FNCE401 assignment 2

Assignment 2

Instructions
Assignment 2 should be submitted after you
have completed Unit 3. This assignment is worth
15 percent of your final grade.
Assignment 2 contains four problems. The
maximum mark for each problem is noted at the beginning of the problem. This
assignment has a total of 100 marks.
Read the requirements for each problem and
plan your responses carefully. Although your responses should be concise,
ensure that you answer each of the required components as completely as
possible. If supporting calculations are required, present them in good form.
When you receive your graded assignment,
carefully review the comments the marker has made. This review component is an
important step in your learning process. If you have any questions or concerns
about the evaluation, please contact the Student Support Centre.

Problem 1
(15 marks)
Suppose the return on portfolio P has the following
probability distribution:

Bear Market

Normal market

Bull market

Probability

0.2

0.5

0.3

Return on P

-20%

18%

50%

Assume that the risk-free rate is 9%, and the
expected return and standard deviation on the market portfolio M is 0.19 and
0.20, respectively. The correlation coefficient between portfolio P and the
market portfolio M is 0.6.
Answer the following questions:
1.
Is P efficient?

2.
What is the beta of portfolio P?

3.
What is the alpha of portfolio P? Is P
overpriced or underpriced?

Problem 2
(20 marks)
Consider a two factor
economy. Assume the risk-free rate = 3%, and the risk premiums are
RP1 = 10%, RP2 = 8%. The return on stock ABC is generated
according to the following equation:
rABC=0.08-0.55F1+1.2F2+eABC
Assume that the stock
is currently priced at $50 per share.
1.
What is the
expected return for stock ABC using the APT?

2.
Is stock
ABC underpriced or overvalued?

3.
If the
expected price next year will be $55, what is the stock price now that will not
allow for arbitrage profits?

4.
Assume that
the risk free rate increases to 4%, with the other variables remaining
unchanged. Would you recommend to buy or
sell stock ABC?

Problem 3 (15
marks)
Suppose that the index model for two Canadian
stocks HD and ML is estimated with the following results:
RHD =0.02+0.80RM+eHD
R-squared =0.6
RML =-0.03+1.50RM+eML
R-squared =0.4
?M
=0.20
where M is S&P/TSX Comp Index, RX
is the excess return of stock X.
1.
What is the standard deviation of each
stock?

2.
What is the systematic risk of each
stock?

3.
What are the covariance and
correlation coefficient between HD and ML?

4.
For portfolio P with investment
proportion of 0.3 in HD and 0.7 in ML, calculate the systematic risk,
non-systematic risk and total risk of P.

Problem 4
(50 marks)
Using the .finance.yahoo.com”>Yahoo! Finance website, search the Bank of Nova Scotia (BNS.TO)by finding
its stock symbol.If
you are unable to locate the prices for BNS.TO, use prices for BNS (the Bank of
Nova Scotia observed in US dollars at the New York Stock Exchange). For the
purpose of this question, assume that the Canadian dollar and the US dollar had
been exchanged one for one.Find
historical prices for the stock (on the left-hand menu) and complete the
following:
1.
Download historical data for
the stock prices (adj. close) from January 1, 2004 through January 1, 2012, on
a monthly basis. You will also need to download
corresponding monthly prices for the S&P/TSX Comp index (also available on
the Yahoo! Finance site) as well as 3-month T-Bill rates (download this
attachment: .athabascau.ca/course/fnce401/v5and6/T-Bill%20Rates.xlsx”>T-Bill
Rates.xlsx).

2.
Calculate returns for both
series of prices downloaded from Yahoo site (BNS and S&P /TSX Comp Index).
Prior to that, make sure the data is sorted in ascending order (i.e., first row
has the oldest data). The final
spreadsheet should have the two series of returns you downloaded and calculated
from Yahoo! Finance. Make sure all data
is expressed in same units.

3.
Using the Tools menu in EXCEL,
(Tool Pack has to be installed if EXCEL does not show it) perform regression
analyses using the Market Model for BNS.

4.
Clearly provide the regression
results in a table with an explanation for the coefficients obtained, and clear
interpretation. Specifically, for each regression provide:
·
Dependent Variable
·
Independent Variable
·
Intercept
·
Beta Value
·
Firm Specific Risk

i.
How well does the S&P/TSX Comp Index movement
explain the variability of the return on BNS stock?

ii.
What is the alpha of the BNS stock?

iii.
Calculate the standard deviation of the stock
return (using the equation for R2=?2?M2/?2,
and the individual regression results).

iv.
Calculate systematic risk and firm specific risk
for the stock.