1. What is the average annual (historic) return on the hedge fund? Remember the reported returns are monthly. Multiply by 12 to get annual returns.¹ Round to three decimals.

¹ This is an approximation which works well enough for our purpose.

2. What is the average annual (historic) return on the stock market? Remember the reported returns are monthly. Round to three decimals.

3. What is the average annual (historic) return on the risk-free asset? Remember the reported returns are monthly. Round to three decimals.

4. What is the annualized standard deviation of the hedge fund return? Remember, you have been given monthly, not annual, returns, but I am asking for the annual standard deviation. You

should use the Excel function STDEV.S( ).

5. What is the annualized standard deviation of the stock market return?

6. What is the annualized standard deviation of the risk-free return?

7. Given that investors like expected return and dislike risk, if standard deviation of return was the correct measure of risk, which of the three assets would you expect investors to choose (if

they can choose only one)?

a.) Hedge Fund

b.) Stock Market

c.) Risk-free asset

8. A regression is a statistical method of creating a straight line that best fits the data. It tells us how two variables are related. The CAPM regression is used to partition the risk of an asset (the standard deviation you measured above) into the systematic component and the idiosyncratic component. Run the following regression in Excel for the hedge fund returns:

rHedgeFundrRiskfree=+(rMarketrRiskfree)+

What is the of the hedge fund? Report four digits behind the decimal. The tells you how much systematic risk the asset has. It will also determine the discount rate we would use in a DCF (for an all-equity company) and is used to calculate the expected return in an efficient market. If you find it useful, you can graph the excess return on the hedge fund against the excess return on the stock market and then draw the regression line through the data.

9. The stock market was up 2.27% in February of 2005. Given your CAPM regression how did the hedge fund perform? Hint: The expected return according to the CAPM just uses beta and

assumes that alpha is zero.

a.) Better than expected b.) as expected c.) worse than expected d.) can't tell from the data presented

10. What is the annualized (i.e. the regression intercept multiplied by 12)? In an efficient market and a world without noise, it will be zero. In practice is not zero because of noise in the

data, because money managers have investment skill (positive ), they are lucky (positive ) or unlucky (negative ) or because money managers are incompetent (negative ).

11. Given your CAPM estimates, what fraction of your financial assets would you allocate to the hedge fund, if you were able to invest in it? Remember, it is an exclusive fund and it not open

to all investors. You will get full credit for any reasonable answer. I just want to know what you think.

Reminder: Enter your answer as a decimal, so if, for example, you would invest 1% of your assets, enter 0.01 ... if you would invest half of your assets, enter 0.5.

A B C D E F G Riskfree RM-RF RHF-RF 1 May Monthly Returns 2 1990 December 3 1991 January 4 February 5 March 6 April 7 May 8 June 9 July 10 August 11 September 12 October 13 November 14 December 15 1992 January 16 February 17 March 18 April 19 20 June 21 July 22 August 23 September 24 October 25 November 26 December 1993 January 28 February 29 March 30 April 31 May 32 June 33 July 34 August 35 September 36 October 37 November 38 December 39 1994 January 40 February 41 March 42 April 43 May 44 June 45 July 46 August 47 September 48 October 49 November 50 December 51 1995 January 52 February 53 March 54 April 55 May 56 June 57 July 58 August 59 September 60 October 61 November 62 December Hedge Fund 2.83% 3.08% 1.46% 0.59% 1.39% 1.88% 0.37% 2.04% 1.07% 0.80% 2.82% 0.06% 1.63% 0.49% 2.79% 1.01% 2.86% -0.19% 1.29% 0.00% 0.92% 0.40% 1.40% 1.42% 1.43% 0.00 1.93% 1.86% 0.06% 1.72% 0.86% 0.09% 1.78% 0.35% 1.77% 0.26% 0.45% 2.18% -0.36% 1.52% 1.82% 0.51% 0.29% 1.78% 0.42% 0.82% 1.88% -0.55% 0.66% 0.92% 0.76% 0.84% 1.69% 1.72% 0.50% 1.08% -0.16% 1.70% 1.60% 0.51% 1.10% Stock Market 2.95% 4.91% 7.58% 2.89% 0.33% 4.07% -4.40% 4.68% 2.68% -1.10% 1.78% -3.73% 10.68% -0.12% 1.34% -2.37% 1.34% 0.64% -1.93% 3.99% -2.08% 1.24% 1.10% 4.02% 1.78% 1.26% 0.54% 2.51% -2.54% 2.96% 0.54% -0.08% 3.95% 0.06% 1.81% -1.76% 1.95% 3.15% -2.42% -4.58% 0.95% 0.94% -2.79% 3.06% 4.26% -1.84% 1.45% -3.72% 1.26% 2.04% 3.96% 2.70% 2.50% 3.40% 3.12% 4.08% 0.93% 3.64% -1.13% 4.27% 1.52% 0.46% 0.46% 0.45% 0.49% 0.45% 0.45% 0.43% 0.46% 0.44% 0.42% 0.39% 0.33% 0.32% 0.29% 0.31% 0.33% 0.27% 0.30% 0.29% 0.25% 0.26% 0.22% 0.21% 0.24% 0.23% 0.21% 0.23% 0.23% 0.24% 0.25% 0.23% 0.24% 0.25% 0.20% 0.23% 0.24% 0.24% 0.22% 0.24% 0.28% 0.30% 0.32% 0.29% 0.32% 0.35% 0.36% 0.36% 0.38% 0.30% 0.43% 0.42% 0.48% 0.48% 0.46% 0.44% 0.45% 0.44% 0.43% 0.42% 0.46% 0.38% A B C D E F Riskfree RM-RF RHF-RF Hedge Fund Stock Market 1 Monthly Returns TUTU VILTU 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 LOO 101 102 LO3 104 105 106 LOZ 108 November December 1996 January February March April May June July August September Octob November December 1997 January February March April May June July August September October November December 1998 January February March April May June July August September October November December 1999 January February March April May June July August September October November December 2000 January February March April May June July August September October 0.51% 1.10% 1.49% 0.73% 1.23% 0.64% 1.41% 0.22% 1.92% 0.27% 1.22% 1.10% 1.58% 0.48% 2.45% 0.73% 0.86% 1.17% 0.63% 1.34% 0.75% 0.35% 2.39% 0.55% 1.56% 0.42% 0.91% 1.29% 1.75% 0.42% 1.76% 1.28% 0.83% 0.28% 1.04% 1.93% 0.84% 0.33% 2.06% 0.17% 2.29% 0.36% 1.51% 1.76% 0.43% 0.94% 0.73% 1.11% 1.61% 0.39% 2.20% 0.20% 1.84% 0.34% 1.37% 0.80% 0.66% 1.32% 0.25% 0.92% 4.27% 1.52% 2.81% 1.63% 1.09% 2.55% 2.68% -0.83% -5.38% 3.25% 5.30% 1.36% 6.55% -1.14% 5.34% -0.11% -4.48% 4.23% 7.16% 4.41% 7.65% -3.63% 5.84% -3.45% 3.05% 1.78% 0.45% 7.32% 5.13% 1.09% -2.58% 3.20% -2.33% -15.77% 6.38% 7.44% 6.20% 6.31% 3.83% -3.81% 3.79% 4.90% -2.07% 5.10% -3.06% -1.00% -2.29% 6.20% 3.69% 8.39% -3.97% 3.18% 5.36% -5.95% -3.90% 5.16% -1.71% 7.58% -5.11% -2.46% 0.46% 0.38% 0.39% 0.39% 0.43% 0.40% 0.41% 0.40% 0.40% 0.41% 0.42% 0.41% 0.41% 0.41% 0.41% 0.42% 0.44% 0.41% 0.37% 0.42% 0.41% 0.42% 0.40% 0.41% 0.42% 0.38% 0.40% 0.43% 0.44% 0.38% 0.38% 0.39% 0.39% 0.39% 0.26% 0.29% 0.37% 0.35% 0.37% 0.38% 0.39% 0.37% 0.37% 0.35% 0.37% 0.37% 0.36% 0.36% 0.38% 0.40% 0.45% 0.44% 0.49% 0.44% 0.39% 0.47% 0.49% 0.50% 0.48% 0.50% 109 110 111 112 113 114 115 116 117 118 119 120 A B D E F G Riskfree RM-RF RHF-RF July 142 Hedge Fund 0.92% 0.68% 0.43% 2.21% 0.14% 1.13% 1.32% 0.32% 0.23% 0.44% 1.01% 0.73% 1.28% 1.21% 0.19% 0.03% 0.60% 0.46% 1.16% 2.12% 0.26% 3.36% -0.06% 0.13% 0.73% 0.16% 0.06% -0.27% 0.40% 1.97% 0.10% 0.95% 1.00% 1.44% 0.22% 0.93% 1.32% -0.08% 0.32% 0.94% 0.50% 0.05% 0.43% 0.66% 1.28% 0.08% 1.33% 0.53% 0.03% 0.79% 0.24% 0.51% 0.37% 0.85% 0.14% 0.63% 1 Monthly Returns 120 October 121 November 122 December 123 2001 January 124 February 125 March 126 April 127 | May 128 June 129 130 August 131 September 132 October 133 November 134 December 135 2002 January 136 February 137 March 138 April 139 May 140 June 141 July August 143 September 144 October 145 November 146 December 147 2003 January February 149 March 150 April 151 May June 153 July 154 August 155 September 156 October 157 November 158 December 159 2004 January 160 February 161 March 162 April 163 May 164 June 165 July 166 August 167 September 168 October 169 November 170 December 171 2005 January 172 February 173 March 174 April 175 May 176 177 Annual Average 178 Annual Std Dev 179 180 Stock Market -2.46% -10.25% 2.03% 3.95% -9.93% -7.03% 8.39% 1.06% -1.75% -1.83% -5.91% -9.15% 2.80% 7.87% 1.78% -1.61% -2.17% 4.47% -4.96% -1.05% -7.02% -8.11% 0.80% -10.00% 7.50% 6.13% -5.33% -2.34% -1.54% 1.03% 8.28% 6.35% 1.63% 2.31% 2.49% -0.91% 6.03% 1.66% 4.55% 2.31% 1.55% -1.07% -2.42% 1.41% 2.16% -3.77% 0.27% 2.06% 1.78% 4.82% 3.52% -2.66% 2.27% -1.69% -2.52% 3.79% 0.50% 0.49% 0.48% 0.40% 0.40% 0.37% 0.31% 0.28% 0.28% 0.30% 0.28% 0.20% 0.18% 0.16% 0.14% 0.14% 0.15% 0.14% 0.15% 0.14% 0.14% 0.14% 0.14% 0.13% 0.12% 0.10% 0.09% 0.10% 0.10% 0.10% 0.09% 0.09% 0.07% 0.07% 0.08% 0.07% 0.08% 0.08% 0.07% 0.07% 0.08% 0.08% 0.07% 0.08% 0.09% 0.10% 0.12% 0.12% 0.14% 0.17% 0.15% 0.18% 0.21% 0.22% 0.23% 0.23% 148 152 A B C D E F G Riskfree RM-RF RHF-RF 1 May Monthly Returns 2 1990 December 3 1991 January 4 February 5 March 6 April 7 May 8 June 9 July 10 August 11 September 12 October 13 November 14 December 15 1992 January 16 February 17 March 18 April 19 20 June 21 July 22 August 23 September 24 October 25 November 26 December 1993 January 28 February 29 March 30 April 31 May 32 June 33 July 34 August 35 September 36 October 37 November 38 December 39 1994 January 40 February 41 March 42 April 43 May 44 June 45 July 46 August 47 September 48 October 49 November 50 December 51 1995 January 52 February 53 March 54 April 55 May 56 June 57 July 58 August 59 September 60 October 61 November 62 December Hedge Fund 2.83% 3.08% 1.46% 0.59% 1.39% 1.88% 0.37% 2.04% 1.07% 0.80% 2.82% 0.06% 1.63% 0.49% 2.79% 1.01% 2.86% -0.19% 1.29% 0.00% 0.92% 0.40% 1.40% 1.42% 1.43% 0.00 1.93% 1.86% 0.06% 1.72% 0.86% 0.09% 1.78% 0.35% 1.77% 0.26% 0.45% 2.18% -0.36% 1.52% 1.82% 0.51% 0.29% 1.78% 0.42% 0.82% 1.88% -0.55% 0.66% 0.92% 0.76% 0.84% 1.69% 1.72% 0.50% 1.08% -0.16% 1.70% 1.60% 0.51% 1.10% Stock Market 2.95% 4.91% 7.58% 2.89% 0.33% 4.07% -4.40% 4.68% 2.68% -1.10% 1.78% -3.73% 10.68% -0.12% 1.34% -2.37% 1.34% 0.64% -1.93% 3.99% -2.08% 1.24% 1.10% 4.02% 1.78% 1.26% 0.54% 2.51% -2.54% 2.96% 0.54% -0.08% 3.95% 0.06% 1.81% -1.76% 1.95% 3.15% -2.42% -4.58% 0.95% 0.94% -2.79% 3.06% 4.26% -1.84% 1.45% -3.72% 1.26% 2.04% 3.96% 2.70% 2.50% 3.40% 3.12% 4.08% 0.93% 3.64% -1.13% 4.27% 1.52% 0.46% 0.46% 0.45% 0.49% 0.45% 0.45% 0.43% 0.46% 0.44% 0.42% 0.39% 0.33% 0.32% 0.29% 0.31% 0.33% 0.27% 0.30% 0.29% 0.25% 0.26% 0.22% 0.21% 0.24% 0.23% 0.21% 0.23% 0.23% 0.24% 0.25% 0.23% 0.24% 0.25% 0.20% 0.23% 0.24% 0.24% 0.22% 0.24% 0.28% 0.30% 0.32% 0.29% 0.32% 0.35% 0.36% 0.36% 0.38% 0.30% 0.43% 0.42% 0.48% 0.48% 0.46% 0.44% 0.45% 0.44% 0.43% 0.42% 0.46% 0.38% A B C D E F Riskfree RM-RF RHF-RF Hedge Fund Stock Market 1 Monthly Returns TUTU VILTU 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 LOO 101 102 LO3 104 105 106 LOZ 108 November December 1996 January February March April May June July August September Octob November December 1997 January February March April May June July August September October November December 1998 January February March April May June July August September October November December 1999 January February March April May June July August September October November December 2000 January February March April May June July August September October 0.51% 1.10% 1.49% 0.73% 1.23% 0.64% 1.41% 0.22% 1.92% 0.27% 1.22% 1.10% 1.58% 0.48% 2.45% 0.73% 0.86% 1.17% 0.63% 1.34% 0.75% 0.35% 2.39% 0.55% 1.56% 0.42% 0.91% 1.29% 1.75% 0.42% 1.76% 1.28% 0.83% 0.28% 1.04% 1.93% 0.84% 0.33% 2.06% 0.17% 2.29% 0.36% 1.51% 1.76% 0.43% 0.94% 0.73% 1.11% 1.61% 0.39% 2.20% 0.20% 1.84% 0.34% 1.37% 0.80% 0.66% 1.32% 0.25% 0.92% 4.27% 1.52% 2.81% 1.63% 1.09% 2.55% 2.68% -0.83% -5.38% 3.25% 5.30% 1.36% 6.55% -1.14% 5.34% -0.11% -4.48% 4.23% 7.16% 4.41% 7.65% -3.63% 5.84% -3.45% 3.05% 1.78% 0.45% 7.32% 5.13% 1.09% -2.58% 3.20% -2.33% -15.77% 6.38% 7.44% 6.20% 6.31% 3.83% -3.81% 3.79% 4.90% -2.07% 5.10% -3.06% -1.00% -2.29% 6.20% 3.69% 8.39% -3.97% 3.18% 5.36% -5.95% -3.90% 5.16% -1.71% 7.58% -5.11% -2.46% 0.46% 0.38% 0.39% 0.39% 0.43% 0.40% 0.41% 0.40% 0.40% 0.41% 0.42% 0.41% 0.41% 0.41% 0.41% 0.42% 0.44% 0.41% 0.37% 0.42% 0.41% 0.42% 0.40% 0.41% 0.42% 0.38% 0.40% 0.43% 0.44% 0.38% 0.38% 0.39% 0.39% 0.39% 0.26% 0.29% 0.37% 0.35% 0.37% 0.38% 0.39% 0.37% 0.37% 0.35% 0.37% 0.37% 0.36% 0.36% 0.38% 0.40% 0.45% 0.44% 0.49% 0.44% 0.39% 0.47% 0.49% 0.50% 0.48% 0.50% 109 110 111 112 113 114 115 116 117 118 119 120 A B D E F G Riskfree RM-RF RHF-RF July 142 Hedge Fund 0.92% 0.68% 0.43% 2.21% 0.14% 1.13% 1.32% 0.32% 0.23% 0.44% 1.01% 0.73% 1.28% 1.21% 0.19% 0.03% 0.60% 0.46% 1.16% 2.12% 0.26% 3.36% -0.06% 0.13% 0.73% 0.16% 0.06% -0.27% 0.40% 1.97% 0.10% 0.95% 1.00% 1.44% 0.22% 0.93% 1.32% -0.08% 0.32% 0.94% 0.50% 0.05% 0.43% 0.66% 1.28% 0.08% 1.33% 0.53% 0.03% 0.79% 0.24% 0.51% 0.37% 0.85% 0.14% 0.63% 1 Monthly Returns 120 October 121 November 122 December 123 2001 January 124 February 125 March 126 April 127 | May 128 June 129 130 August 131 September 132 October 133 November 134 December 135 2002 January 136 February 137 March 138 April 139 May 140 June 141 July August 143 September 144 October 145 November 146 December 147 2003 January February 149 March 150 April 151 May June 153 July 154 August 155 September 156 October 157 November 158 December 159 2004 January 160 February 161 March 162 April 163 May 164 June 165 July 166 August 167 September 168 October 169 November 170 December 171 2005 January 172 February 173 March 174 April 175 May 176 177 Annual Average 178 Annual Std Dev 179 180 Stock Market -2.46% -10.25% 2.03% 3.95% -9.93% -7.03% 8.39% 1.06% -1.75% -1.83% -5.91% -9.15% 2.80% 7.87% 1.78% -1.61% -2.17% 4.47% -4.96% -1.05% -7.02% -8.11% 0.80% -10.00% 7.50% 6.13% -5.33% -2.34% -1.54% 1.03% 8.28% 6.35% 1.63% 2.31% 2.49% -0.91% 6.03% 1.66% 4.55% 2.31% 1.55% -1.07% -2.42% 1.41% 2.16% -3.77% 0.27% 2.06% 1.78% 4.82% 3.52% -2.66% 2.27% -1.69% -2.52% 3.79% 0.50% 0.49% 0.48% 0.40% 0.40% 0.37% 0.31% 0.28% 0.28% 0.30% 0.28% 0.20% 0.18% 0.16% 0.14% 0.14% 0.15% 0.14% 0.15% 0.14% 0.14% 0.14% 0.14% 0.13% 0.12% 0.10% 0.09% 0.10% 0.10% 0.10% 0.09% 0.09% 0.07% 0.07% 0.08% 0.07% 0.08% 0.08% 0.07% 0.07% 0.08% 0.08% 0.07% 0.08% 0.09% 0.10% 0.12% 0.12% 0.14% 0.17% 0.15% 0.18% 0.21% 0.22% 0.23% 0.23% 148 152