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Market rate of return - Assignment Example

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Market rate of return

If it is observed that the returns are consistently below the SML line, it will mean that the stock is expected to rise, while if the returns are seen to be consistently above the line, then it will mean that the stock is due for a drop. Graphing the SML for a particular stock requires a stock with a beta that is higher than 1 and this usually outperforms the market, while a beta that is less than 1 implies that it underperforms the market (Shanken, 56). The y-intercept of the SML is equal to risk-free rate. The SML slope is equal to market risk premium and it usually reflects the return trade of a given time. Beta is termed as non-diversifiable or systematic risk. Basing on the generated regression line the equation created is=8.375x-0.166 Going by beta values, the security market line indicates that the relationship between return and risk is linear for the individual securities. For instance, increased return= increased risk. Essentially it indicates what return someone needs to earn on an investment for it to be worth taking, and this is seen to increase with the investment riskiness. The Security Market Line formula is as below: Required Return = Risk Free Rate + (Beta x [Market Return - Risk Free Rate]) Calculate 95% confidence intervals for the slope and y-intercept. SUMMARY OUTPUT Regression Statistics Multiple R 0.997314 R Square 0.994636 Adjusted R Square 0.992848 Standard Error 0.005276 Observations 5 ANOVA   df SS MS F Significance F Regression 1 0.015486 0.015486 556.2975 0.000167 Residual 3 8.35E-05 2.78E-05 Total 4 0.01557         Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept 0.020428 0.004799 4.256403 0.023776 0.005154 0.035702 0.005154 0.035702 X Variable 1 0.118761 0.005035 23.58596 0.000167 0.102737 0.134786 0.102737 0.134786 RESIDUAL OUTPUT Observation Predicted Y Residuals 1 0.04418 0.00582 2 0.079809 -0.00481 3 0.109499 -0.0045 4 0.162942 0.002058 5 0.19857 0.00143 Look up the current return on one-year Treasury bills/notes as your risk-free rate. Two good sources. In your report, please state your source and the date used. http://fxtrade.oanda.com/analysis/economic-indicators/united-states/rates/yield-curve Date used; November 29, 2013 My risk free rate is 0.05 Given the current risk-free rate, is the regression estimate of your risk-free rate match the actual current risk-free rate? Use confidence intervals to help answer this question. Basing on the confidence interval calculation above, the regression estimate of my risk free rate does not match the actual current risk-free rate because it falls outside the interval or range of 0.10273 and 0.13478 What is the current expected market rate of return (based on your regression)? Basing on my regression, the current expected market rate of return is as below; Using the equation generated from the regression; Y=8.375x-0.166 The current expected market rate of return is equal to X Therefore X=(y+0.166)/8.375 But we are given Y which is 0.05. The X will now be (0.05+0.166)/8.375=0.02579 Therefore, the current expected market rate of return is 0.02579 Works Cited Shanken, J.On the Estimation of Beta-Pricing Models,"Review of Financial Studies, 5(1), 1{33,1992. Print Shanken, J.,and G. ...Show more

Summary

The security market line (SML) Determination of the y-intercept and the slope of the security market line by running a regression line (appendix); after running a regression line the slope is 8.375 and the y intercept is -0.166 Interpretation of my regression, this includes what the y-intercept and the slope mean in terms we have used in this class…
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