An analyst for Phidelity Investments wants to develop a regression model to predict the annual rate of return for a stock based on the price-earnings (PE) ratio of the stock and a measure of the stock’s risk. The data found in the file Dat9-12.xls were collected for a random sample of stocks.

a. Prepare scatter plots for each independent variable versus the dependent variable. What type of model do these scatter plots suggest might be appropriate for the data?

b. Let Y = Return, X1 = PE Ratio, and X2 = Risk. Obtain the regression results for the following regression model:

Ŷi = b0 + b1X1i + b2X2i

Interpret the value of R2 for this model.

c. Obtain the regression results for the following regression model:

Ŷi = b0 + b1X1i + b2X2i + b3X3i + b4X4i

Where X3i = X12i and X4i = X2 2i. Interpret the value of R2 for this model.

d. Which of the previous two models would you recommend that the analyst use?