Problem: A security analyst estimates the excess return of the equity of a firm

Question

Problem: A security analyst estimates the excess return of the equity of a firm by run- ning a regression on the Single-Factor Indiex Model. In his regression output R-square is 0.9. A: State in words what this result means for the investor. What percentage of the varia- tion in his data on firm excess returns is not attributable to the variation of the market excess retrun? B: Both beta and standard deviation are measures of risk. How do these two measures differ? Specifically what type(s) of risk does each statistic capture? C: State in words the two main results of the CAPM.

Explanation / Answer

A. The value of R-square will give information about what percentage of the variation of the dependent variable is explained by the given independent variable. Here, the value is 0.9 i.e, 90% of the total variation in the excess return in the equity of the firm is attributable to the variation of the market excess return. Remaining 10% is not attributable.

B. Both beta and standard deviation are measures of risk. Beta is a measure of systematic risk. These are non diversifiable risks which are common to the whole economy or industry. These risks involves interest rate risk, purchasing power risk, inflation risk, risk due to political instability, recession etc.

Standard deviation is a measure of unsystematic risk. These risks are unique for a company and this can be avoided by diversification. These risks occurs due to micro economic factors like demand supply gap, bad company policies etc.

C. The two main results of Captal Asset Pricing Model (CAPM) are:

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

---

---

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