According to the capital Asset pricing model (CAPM), the risk associated with a capital asset is proportional to the slope obtaining by regressing the asset’s past returns with the corresponding returns of the average portfolio called the market portfolio. (The return of the market portfolio represents the return earned by the average investor. It is a weighted average of the returns from all the assets in the market). The larger the slope of an asset, the larger is the risk associated with that asset. A of 1.00 represents average risk. The return from an electronics firm’s stock and the corresponding returns for the market portfolio for the past 15 years are given below. Market Return (%)Stock’s Return (%)
1.Carry out the regression and find the for the stock. What is the regression equation?
2.Does the value of the slope indicate that the stock has above average risk? (For the purpose of this case assume that the risk is average if the slope is in the range , below average if it is less than 0.9 and above average if it is more than 1.1).
3.Give a 95% confidence interval for this . Can we say the risk is above average with 95% confidence?
4.If the market portfolio return for the current year is 10%, what is the stock’s return predicted by the regression equation? Give a 95% confidence interval for this prediction.
Case Study 1.
A company supplies pins in bulk to a customer. The company uses an automatic lathe to produce the pins. Due to many causes- vibration, temperature, wear and tear and the like-the length of the pins made by the machines are normally distributed with a mean of 1.012 inches and a standard deviation of...