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FNCE 401 v6 Assignment 2 (2014)




Question;Assignment 2InstructionsAssignment 2 should be submitted after you have completed Unit 3. This assignment isworth15 percent of your final grade.Assignment 2 contains four problems. The maximum mark for each problem is noted atthe beginning of the problem. This assignment has a total of 100 marks.Read the requirements for each problem and plan your responses carefully. Althoughyour responses should be concise, ensure that you answer each of the requiredcomponents as completely as possible. If supporting calculations are required, presentthem in good form.When you receive your graded assignment, carefully review the comments the markerhas made. This review component is an important step in your learning process. If youhave any questions or concerns about the evaluation, please contact the StudentSupport Centre.Problem 1 (15 marks)Suppose the return on portfolio P has the following probability distribution:ProbabilityReturn on PBear Market0.2-20%Normal market0.518%Bull market0.350%Assume that the risk-free rate is 9%, and the expected return and standard deviation onthe market portfolio M is 0.19 and 0.20, respectively. The correlation coefficient betweenportfolio 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 premiumsareRP1 = 10%, RP2 = 8%. The return on stock ABC is generated according to the followingequation:rABC=0.08-0.55F1+1.2F2+eABCAssume 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 willnot allow for arbitrage profits?4. Assume that the risk free rate increases to 4%, with the other variables remainingunchanged. 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 thefollowing results:RHD =0.02+0.80RM+eHDR-squared =0.6RML =-0.03+1.50RM+eMLR-squared =0.4?M =0.20where 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?23. 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, calculatethe systematic risk, non-systematic risk and total risk of P.Problem 4 (50 marks)Using the Yahoo! Finance website, search the Bank of Nova Scotia (BNS.TO) byfinding its stock symbol. If you are unable to locate the prices for BNS.TO, use prices forBNS (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 hadbeen 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, 2004through January 1, 2012, on a monthly basis. You will also need to downloadcorresponding monthly prices for the S&P/TSX Comp index (also available onthe Yahoo! Finance site) as well as 3-month T-Bill rates (download thisattachment: T-Bill Rates.xlsx).2. Calculate returns for both series of prices downloaded from Yahoo site (BNS andS&P /TSX Comp Index). Prior to that, make sure the data is sorted in ascendingorder (i.e., first row has the oldest data). The final spreadsheet should have thetwo 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 doesnot show it) perform regression analyses using the Market Model for BNS.4. Clearly provide the regression results in a table with an explanation for thecoefficients obtained, and clear interpretation. Specifically, for each regressionprovide:?? Independent Variable? Intercept? Dependent VariableBeta Value? Firm Specific Riski.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.4How well does the S&P/TSX Comp Index movement explain the variability of the return on BNS stock?Calculate systematic risk and firm specific risk for the stock.


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