Question

You run a regression of monthly returns of firm A on the S&P 500 index with an expected return of 12% and obtain the following output:

1. Intercept of the regression = 0.052
2. Coefficient on the market return = 0.5

a. What would an investor in firm A's stock require as a return, if the T-Bond rate is 2%?

b. Did your stock perform better than the market? Explain.

Answer 1

Solution:

Regression result is as follows

1. Intercept of the regression = 0.052
2. Coefficient on the market return = 0.5

Beta is the cofficient hence  Beta = 0.5

Market return = 12%

Risk free rate = 2%

Part A )

Required return of A = Risk free rate + Beta x (Market return-Risk free rate)

Required return of A =2% + 0.5 x (12%-2%) = 7%

Part B )

The stock has return of 7% while the market return is 12%, hence the stock has performed worse than the market.