R 11 Risk and Roturn 387 CHAPTER CASE The Beta for FLIR Syster foey Moss, a recent his job with the investmen Paul Covill, one of the 10 Joey about the firm's in me risk of the inve More specifically, because fed portfolio, Paul is conce risk of current and as a recent finance graduate, has just begun with the investment firm of Covili and Wyatt one of the firm's founders, has been talking wabout the firm's investment portfolio with any investment, Paul is concerned about of the investment as well as the potential return specifically, because the company holds a diversi tfolio, Paul is concerned about the systematic of current and potential investments. One position company currently holds is stock in FLIR Systems, FLIRI FLIR Systems designs, manufactures, and Let thermal imaging and infrared camera systems. buah better known for its military applications the company has divisions that design products for other applications such as automotive night vision. commercial products that require minute temperature difference measurements, recreational marine usage. and firefighting Covill and Wyatt currently uses a commercial data vendor for information about its positions. Because of this, Paul is unsure exactly how the numbers provided are calculated. The data provider considers its methods proprietary, and it will not disclose how stock betas and other information are calculated. Paul is uncomfortable with not knowing exactly how these numbers are being computed and also believes that it could be less expen- sive to calculate the necessary statistics in-house. explore this question, Paul has asked Joey to do the fol lowing assignments: QUESTIONS 1 Go to finance.yahoo.com and download the ending monthly stock prices for FLIR Systems (FLIR) for the last 60 months. Be sure to use the adjusted closing price to account for any stock splits and dividend payments. Next, download the ending value of the S&P 500 index over the same period. For the his torical risk-free rate, go to the St. Louis Federal Reserve website (www.stlouisfed.org) and find the three-month Treasury bill constant maturity rate. Download this file. What are the monthly returns, average monthly returns, and standard deviations for FLIR Systems stock, the three-month Treasury bill, and the S&P 500 for this period? 2. Beta is often estimated by linear regression. A model often used is called the market model, which is: R-R,= a + B, [RM - Rp) + In this regression, R. is the return on the stock and R is the risk-free rate for the same period. R.is the return on a stock market index such as the S&P 500 index is the regression intercept, and B is the slope (and the stock's estimated beta), represents the residuals for the regression. What do you think is the motivation for this particular regression? The intercept, a, is often called Jensen's cloha. What does it measure? If an asset has a positive Jensen's alpha, where would it plot with respect to the SML? What is the financial in- terpretation of the residuals in the regression? 3. Use the market model to estimate the beta for FLIR Systems using the last 60 months of returns (the regression procedure in Excel is one easy way to do this). Plot the monthly returns on FLIR Systems against the index and also show the fit- ted line. 4 Compare your beta for FLIR Systems to the beta you find on finance.yahoo.com. How similar are they? Why might they be different? R 11 Risk and Roturn 387 CHAPTER CASE The Beta for FLIR Syster foey Moss, a recent his job with the investmen Paul Covill, one of the 10 Joey about the firm's in me risk of the inve More specifically, because fed portfolio, Paul is conce risk of current and as a recent finance graduate, has just begun with the investment firm of Covili and Wyatt one of the firm's founders, has been talking wabout the firm's investment portfolio with any investment, Paul is concerned about of the investment as well as the potential return specifically, because the company holds a diversi tfolio, Paul is concerned about the systematic of current and potential investments. One position company currently holds is stock in FLIR Systems, FLIRI FLIR Systems designs, manufactures, and Let thermal imaging and infrared camera systems. buah better known for its military applications the company has divisions that design products for other applications such as automotive night vision. commercial products that require minute temperature difference measurements, recreational marine usage. and firefighting Covill and Wyatt currently uses a commercial data vendor for information about its positions. Because of this, Paul is unsure exactly how the numbers provided are calculated. The data provider considers its methods proprietary, and it will not disclose how stock betas and other information are calculated. Paul is uncomfortable with not knowing exactly how these numbers are being computed and also believes that it could be less expen- sive to calculate the necessary statistics in-house. explore this question, Paul has asked Joey to do the fol lowing assignments: QUESTIONS 1 Go to finance.yahoo.com and download the ending monthly stock prices for FLIR Systems (FLIR) for the last 60 months. Be sure to use the adjusted closing price to account for any stock splits and dividend payments. Next, download the ending value of the S&P 500 index over the same period. For the his torical risk-free rate, go to the St. Louis Federal Reserve website (www.stlouisfed.org) and find the three-month Treasury bill constant maturity rate. Download this file. What are the monthly returns, average monthly returns, and standard deviations for FLIR Systems stock, the three-month Treasury bill, and the S&P 500 for this period? 2. Beta is often estimated by linear regression. A model often used is called the market model, which is: R-R,= a + B, [RM - Rp) + In this regression, R. is the return on the stock and R is the risk-free rate for the same period. R.is the return on a stock market index such as the S&P 500 index is the regression intercept, and B is the slope (and the stock's estimated beta), represents the residuals for the regression. What do you think is the motivation for this particular regression? The intercept, a, is often called Jensen's cloha. What does it measure? If an asset has a positive Jensen's alpha, where would it plot with respect to the SML? What is the financial in- terpretation of the residuals in the regression? 3. Use the market model to estimate the beta for FLIR Systems using the last 60 months of returns (the regression procedure in Excel is one easy way to do this). Plot the monthly returns on FLIR Systems against the index and also show the fit- ted line. 4 Compare your beta for FLIR Systems to the beta you find on finance.yahoo.com. How similar are they? Why might they be different
