Business Finance Investment Fall 2016 Assignment #3 CAPM, Linear Factor Models, and Equity Returns Due Date: November 10, 2016

The focus of this assignment is to better understand the CAPM and to implement asset pricing models using actual data. You will need to use a spreadsheet posted on blackboard called hw3data.xlsx. There are two sheets of data. The rst sheet contains the Fama-French factors from January 1963 to December 2011 and should be used with Part 1. The second sheet contains data on three mystery mutual funds (along with Fama-French factors) and should be used for Part 2.

Each group should hand in one copy of their answers. Please show your work and provide explanations where relevant. However, you do not need to print out entire spreadsheets. Your answers should be summarized in a write-up with relevant details of calculations, tables and charts (if applicable), and explanations.

The assignment can be turned in during class. Please print out your Word document or your PDF le. In particular, please do not e-mail an Excel spreadsheet if you feel that the Excel spreadsheet is relevant to providing details of your work, please copy and paste the relevant portions into your Word document.

Part 1: Evaluating Value-Growth For this part of the assignment, you will need to use the HML factor and market excess returns from hw3data.xlsx (in the sheet labeled Fama-French Factors). The HML factor is the dierence in returns between the high book-to-market portfolio and the low book-tomarket portfolio.

1. Report the average of HML. What is the standard error of this estimate? What is the 95% condence interval? Is the average of HML statistically dierent from 0?

2. Report the CAPM beta and alpha of the HML portfolio. Are these estimates statistically signicant? What are the possible economic sources of this alpha?

3. Are the results in (1) or (2) better evidence that a strategy that is long value and short growth generates abnormal returns? Why?

Part 2: Mystery Portfolios For this part of the assignment, use the returns for the mystery mutual funds in hw3data.xlsx. In the sheet labeled Mystery Funds, there are returns for three dierent mutual funds. The funds are:

(a) iShares S&P 500 Value Index (IVE) Large Value (b) iShares S&P Growth Index (IVW) Large Growth (c) iShares Russell 2000 Growth Index (IWO) Small Growth

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1. Report the average excess returns of each of the three funds with a 95% condence interval.

2. Run multivariate regressions of the excess returns of these mystery funds on the three Fama-French factors and report the estimates (with t-statistics).

3. Based on the results of the multivariate regressions, identify which fund is which.

4. Suppose that we believe that the Fama-French 3-factor model properly captures risk. Do the results in (2) indicate that any of the fund managers have an ability to generate returns in excess of the risks that they are taking on?