Question 2 (14 points) The capital asset pricing model (CAPM) is well known in finance. It explains variations in the rate of return on a security as a function of the rate of return on a portfolio consisting of all publicly traded stocks (the so-called market portfolio) Generally the rate of return on an investment is measured relative to its opportunity cost, which is the risk-free return The resulting difference is called the risk premium, since it is the reward or punishment for making a risky investment. The CAPM says that the risk premium on a security is proportional to the risk premium on the market portfolio. That is, where r-return to a security, rf: risk-free return, and r-return on the market portfolio, and is that security's "beta" value. Astock's beta is important to investors since it reveals the stock's volatility. It measures the sensitivity of that security's return to variation in the whole stock market. As such, values of beta less than 1 indicate that the stock is "defensive" since its variation is less than the market's. A beta greater than 1 indicates an "aggressive stock." Investors usually want an estimate of a stock's beta before purchasing it. The CAP model above is the "economic model". The "econometric" model" is obtained by including an intercept in the model (even though theory says it should be zero) and an error term where rprr-risk premium on a security, mpr-(rm-)risk on the market portfolio Answer the following using the data file capm.dta on the monthly returns of six firms-Disney (dis), GE (ge), GM (gm), IBM (ibm), Microsoft (msft), and Mobil-Exxon (xom), the rate of return on the market portfolio (mkt), and the rate of return on the risk free asset (rf). The 132 observations cover January 1998 to December 2008. (a) Estimate the model for each firm, and present your results compactly in the form of a table (See below). You will have a total of six regressions, one for each firm. You would need to generate the dependent andindependent variable for each firm. (5 points) (b) Comment on the estimated beta values. Which firms appear aggressive? Defensive? (3 points) Question 2 (14 points) The capital asset pricing model (CAPM) is well known in finance. It explains variations in the rate of return on a security as a function of the rate of return on a portfolio consisting of all publicly traded stocks (the so-called market portfolio) Generally the rate of return on an investment is measured relative to its opportunity cost, which is the risk-free return The resulting difference is called the risk premium, since it is the reward or punishment for making a risky investment. The CAPM says that the risk premium on a security is proportional to the risk premium on the market portfolio. That is, where r-return to a security, rf: risk-free return, and r-return on the market portfolio, and is that security's "beta" value. Astock's beta is important to investors since it reveals the stock's volatility. It measures the sensitivity of that security's return to variation in the whole stock market. As such, values of beta less than 1 indicate that the stock is "defensive" since its variation is less than the market's. A beta greater than 1 indicates an "aggressive stock." Investors usually want an estimate of a stock's beta before purchasing it. The CAP model above is the "economic model". The "econometric" model" is obtained by including an intercept in the model (even though theory says it should be zero) and an error term where rprr-risk premium on a security, mpr-(rm-)risk on the market portfolio Answer the following using the data file capm.dta on the monthly returns of six firms-Disney (dis), GE (ge), GM (gm), IBM (ibm), Microsoft (msft), and Mobil-Exxon (xom), the rate of return on the market portfolio (mkt), and the rate of return on the risk free asset (rf). The 132 observations cover January 1998 to December 2008. (a) Estimate the model for each firm, and present your results compactly in the form of a table (See below). You will have a total of six regressions, one for each firm. You would need to generate the dependent andindependent variable for each firm. (5 points) (b) Comment on the estimated beta values. Which firms appear aggressive? Defensive? (3 points)