The following is part of the computer output from a regression of monthly return
ID: 2793019 • Letter: T
Question
The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 Index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month.
Now suppose that the manager misestimates the beta of Waterworks stock, believing it to be .50 instead of .75. The standard deviation of the monthly market rate of return is 5%.
a. What is the standard deviation of the (now improperly) hedged portfolio? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Standard deviation %
b. What is the probability of incurring a loss over the next month if the monthly market return has an expected value of 1% and a standard deviation of 5%? (Do not round intermediate calculations. Round your answer to 2 decimal places.)
Probability of a negative return %
Explanation / Answer
In case of improperly hedged portfolio:
Variance = (0.252 × 52) + 62 = 37.5625
Standard deviation =underroot of variance = underrot(37.5625) = 6.13%
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More data needed to solve part B
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