a. What is the characteristic line of XYZ in Example 6.4?

b. Does ABC or XYZ have greater systematic risk?

c. What percent of the variance of XYZ is firm-specific risk?

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EXAMPLE 6.4 Estimating the Index Model Using Historical Data The direct way to calculate the slope and intercept of the characteristic lines for ABC and XYZ is from the variances and covariances. Here, we use the Data Analysis menu of Excel to obtain the covariance matrix in the following spreadsheet. The slope coefficient for ABC is given by the formula BABC The intercept for ABC is Cov(RABC, RMarket) 773.31 Var(RMarket) 684.01 = = 1.156 = OLABC Average(RABC) - BABC X Average (RMarket) 15.20 1.156 x 9.40 = 4.33 Therefore, the security characteristic line of ABC is given by RABC= 4.33 + 1.156 RMarket This result also can be obtained by using the "Regression" command from Excel's Data Analysis menu, as we show at the bottom of the spreadsheet. The minor differences between the direct regression output and our calculations above are due to rounding error.