Question 6 (weight 20%)
You have estimated the Single Index model for two oil companies, Exxon Mobil Corp. (XOM) and Chevron Corp. (CVX), using monthly data of excess returns over the past five years. You have obtained the following results:
R(cvx) = .72% + .56R(m)+e(cvx) R^2(cvx) = .19
R(xom) = .58% + .57R(m) + e(xom) R^2(xom) = .22
R(xom) = .58% + .57R(m) + e(xom) R^2(xom) = .22
The standard deviation of monthly excess market returns is estimated at 4.5%. Recall that the Single Index model assumes that Cov(e(cvx),e(xom)) = 0.
1. What are the standard deviations of the monthly excess returns of CVX and XOM?
2. In the Single Index model, how much of the variance in CVX is due to its systematic component, and how much is due to its firm-specific component?
3. Find the correlation between the excess returns of CVX and XOM implied by the Single Index model
4. You have also directly estimated the correlation coefficient between the excess returns of CVX and XOM to be .78. Briefly explain in words what might account for the difference between the .78 and your answer in 3, and briefly describe how you might improve on the Single Index model to obtain a more precise correlation estimate between the two stocks.
Now, I had put more than 40 hours into studying for this 4-hour exam, and felt my knowledge of the subject matter unequivocally thorough. That having been said, here's an excerpt from my internal monologue upon reading this question:
Is this &*å@ in Danish or what? @$#*. Ok, let's analyze this. The ankle bone's connected to the...thigh bone. No wait, wrong subject. And that's not even correct! Thank God you didn't go into medicine. Although that's an interesting evolutionary proposition. What would people look like if ankles connected to thighs? Squat, undoubtedly, and no way our savanna-dwelling ancestors could have outrun cheetahs and other exotic creatures to survive and reproduce. Great job, Ben, your anatomical supposition would have led to the extinction of mankind. Ok, right, exam, focus...you're being retarded. Well, retarded actually wouldn't be all that bad...Rain Man could probably figure out this crap. And he could just go to Vegas and make a fortune anyways, no need for advanced financial degrees. Just Vegas, fish sticks, and K-mart underwear. No need to deviate from that. Deviate. Standard deviations of the monthly excess returns...you need the derivation of the R^2 formula to solve for that. R-squared. Finance is truly for squares. Heh, that's a pretty good one. Blanking on the formula derivation, so blanking it is.
I walked to the front of the class and joined about 65 other students in turning our papers in blank and leaving. Eye of the Tiger was replaced with a morose violin concerto. Denmark's re-exam system allows students who failed (or turned in blank) exams to try them again 2 months later, and I opted to take that route. I estimate I would have gotten a grade of 7 (average) had I completed the test, but I'm average in too many other respects (see: height, weight, hair color, eye color, etc.) to settle for average grades.
We shall meet again in February FM&I, and next time you won't be so fortunate.
1. What are the standard deviations of the monthly excess returns of CVX and XOM?
2. In the Single Index model, how much of the variance in CVX is due to its systematic component, and how much is due to its firm-specific component?
3. Find the correlation between the excess returns of CVX and XOM implied by the Single Index model
4. You have also directly estimated the correlation coefficient between the excess returns of CVX and XOM to be .78. Briefly explain in words what might account for the difference between the .78 and your answer in 3, and briefly describe how you might improve on the Single Index model to obtain a more precise correlation estimate between the two stocks.
Now, I had put more than 40 hours into studying for this 4-hour exam, and felt my knowledge of the subject matter unequivocally thorough. That having been said, here's an excerpt from my internal monologue upon reading this question:
Is this &*å@ in Danish or what? @$#*. Ok, let's analyze this. The ankle bone's connected to the...thigh bone. No wait, wrong subject. And that's not even correct! Thank God you didn't go into medicine. Although that's an interesting evolutionary proposition. What would people look like if ankles connected to thighs? Squat, undoubtedly, and no way our savanna-dwelling ancestors could have outrun cheetahs and other exotic creatures to survive and reproduce. Great job, Ben, your anatomical supposition would have led to the extinction of mankind. Ok, right, exam, focus...you're being retarded. Well, retarded actually wouldn't be all that bad...Rain Man could probably figure out this crap. And he could just go to Vegas and make a fortune anyways, no need for advanced financial degrees. Just Vegas, fish sticks, and K-mart underwear. No need to deviate from that. Deviate. Standard deviations of the monthly excess returns...you need the derivation of the R^2 formula to solve for that. R-squared. Finance is truly for squares. Heh, that's a pretty good one. Blanking on the formula derivation, so blanking it is.
I walked to the front of the class and joined about 65 other students in turning our papers in blank and leaving. Eye of the Tiger was replaced with a morose violin concerto. Denmark's re-exam system allows students who failed (or turned in blank) exams to try them again 2 months later, and I opted to take that route. I estimate I would have gotten a grade of 7 (average) had I completed the test, but I'm average in too many other respects (see: height, weight, hair color, eye color, etc.) to settle for average grades.
We shall meet again in February FM&I, and next time you won't be so fortunate.
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