Problem 13-18 Consider the following information given below: Month (A) Market R

ID: 2688129 • Letter: P

Question

Problem 13-18 Consider the following information given below: Month (A) Market Return (B) Executive Cheese Return (C) Paddington Beer Return May 07 3.0 -2.8 1.9 Jun -0.8 2.2 -1.7 Jul -3.6 -5.4 -0.9 Aug -0.5 -0.6 -1.4 Sep 2.4 3.7 3.7 Oct 3.0 13.6 3.8 Nov -5.3 2.0 -4.9 Dec -0.9 7.0 -1.0 Jan 08 -10.5 -7.0 -5.3 Feb -1.6 -0.5 -1.1 Mar 2.6 -2.2 -2.5 Apr 9.3 6.0 3.1 May -0.8 -0.7 0.3 Jun -6.0 -11.7 -7.4 Jul -2.1 1.9 -3.6 Aug 5.7 8.2 3.0 Sep -13.4 -16.9 -8.7 Oct -12.2 -5.2 -14.3 Nov -2.4 -0.9 -4.9 Dec 4.3 4.7 -2.8 Jan 09 -6.3 -8.7 -0.4 Feb -7.3 2.3 -10.7 Requirement 1: Calculate the abnormal return for Executive Cheese. (Round your answer to 2 decimal places. Omit the "%" sign in your response.) Abnormal return % Requirement 2: Calculate the abnormal return for Paddington Beer. (Round your answer to 2 decimal places. Negative amount should be indicated by a minus sign. Omit the "%" sign in your response.) Abnormal return % Requirement 3: Calculate the average abnormal return of the two stocks during the month of the earnings announcement. (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places. Omit the "%" sign in your response.) Average abnormal return %

Explanation / Answer

There are several ways to approach this problem, but all (when done correctly!) should give approximately the same answer. We have chosen to use the regression analysis function of an electronic spreadsheet program to calculate the alpha and beta for each security. The regressions are in the following form:

Security return = alpha + (beta ´ market return) + error term

The results are:

Alpha

Beta

Executive Cheese

-0.89

0.50

Paddington Beer

-0.51

2.01

(As a point of interest, the R2 for the Executive Cheese regression is 0.082, which is relatively low for a regression of this type. For Paddington Beer, it is 0.74, a relatively high value.)

The abnormal return for Executive Cheese

5.6 – [-0.89 + 0.50 ´ (-5.7)] = 9.34%

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For Paddington Beer

-11.1 – [-0.51 + 2.01 ´ (-9.5)] = 8.51%

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Thus, the average abnormal return of the two stocks during the month of the dividend announcement was 8.93 percent.