1. (a) Given the following regression results, Estimated \'s for Stock A: = .85

Question

1. (a) Given the following regression results,

            Estimated 's for Stock A:   = .85               SMB = 1.04      HML = -.39

            Estimated 's for Stock B:   = 1.18              SMB = -.59         HML = .14

            Historical Average Annual Return: Rm - Rf = .0781          

                                                                        RSMB = .0364  

                                                                        RHML = .0412

            Current Risk-Free Rate:                     Rf = .01

Estimate the expected annual return on the market and on Stock A and Stock B for 2015

                        (i) using CAPM

                        (ii) using the Fama/French 3 Factor Model.

(b) Why does the Fama/French model give a different answer than CAPM? Explain.

(c) Which company A or B is larger in terms of market capitalization and which has higher growth

options? Explain.

Explanation / Answer

1a

Expected return on stock B using CAPM = 0.01 + (1.18*0.0781) = 0.102

Return on stock A =0.098

Return on Stock B = 0.086

1b Fama/ French model takes three factors instead of one factor CAPM model. Addition two factors are small cap and price to book ratio in addition to beta. Thus the returns calculated will be different

1c Firm B is larger in market capitalisation because of lower SMB factor. The factor is negative thus firm did not benefit from small firm capitalisation. Also company A has higher growth options due to higher HML and grater sensitivity

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.