You are interested in modeling the behavior of stocks. In particular, you want to build a model that describes the rate of return on a  basket of stocks, such as large capitalization companies.

(a) Go to a website that provides historical rates of return on a certain basket of stocks, such as www.morningstar.com. Decide on a certain sector of the economy you would like to model, such as consumer goods or energy. Choose the largest 100 companies in this sector and determine the time frame for which you want to build your model. For example, you might decide to build a model for the one-year rate of return on the stock.

(b) Enter your data into statistical software and construct a relative frequency histogram. Does the data appear bell-shaped? Do you think the normal model would be a good model to describe the rate of return for the sector you have chosen? Why or why not?

(c) Regardless of your answer to part (b), build a normal model by determining the mean and standard deviation for the rate of return. Draw the normal model on the relative frequency histogram from part (b).

(d) One purpose of financial models is to identify quality investments going forward. Without a crystal ball, all investment managers have is historical data. Use your historical data to determine a rate of return that falls into the top 20% of all companies within the sector. Use this rate of return as a criterion for choosing a company to invest in.

(e) Conduct further research on the stock you wish to invest in. For example, have the company’s earnings been growing for the past five years? What is the company’s market share? Does the company pay a dividend? If so, for how long has the company paid a dividend? Has the dividend been growing consistently?

(f) Write a report that lays out your recommendation regarding the particular stock you have researched. Perhaps include a few other models that might help to decide whether the company is a solid investment.