Assume that it is year 2000. The following data are available for the XYZ Corpor

Question

Assume that it is year 2000. The following data are available for the XYZ Corporation :

Year Market Return Company Returns 1999 1998 1997 1996 1995 1994 0.27 0.12 0.03 0.12 0.03 0.27 0.25 0.05 0.05 0.15 0.10 0.30 Assume that the risk -free rate is 0.066. Calculate: a) the expected market return; b) the variance of the market return; (c) the expected return for XY2 (d) the covariance of the return for XYZ with the return on the mar ket (e) Write the equation for the security market line. (f) What is the required rate of return for XYZ? g) Discuss how the approach used for estimation in this question differs from that in the last problem

Explanation / Answer

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(a) Expected Market return Expected market return is Simple Average of Market returns Expected market return = [0.27+0.12+(-0.03)+0.12+(-0.03)+0.27 ]/6 =0.12 (b) variance of the Market Return Year Market Return Expected return Market return - expected return (Market return - expected return)^2 1999 0.27 0.12 0.15 0.0225 1998 0.12 0.12 0 0 1997 -0.03 0.12 -0.15 0.0225 1996 0.12 0.12 0 0 1995 -0.03 0.12 -0.15 0.0225 1994 0.27 0.12 0.15 0.0225 Total 0.09 Variance of the market return = Total of ((Market return - expected return)^2) / no of years = 0.09/6 =0.015 (c) Expected return for XYZ Expected XYZ return is Simple Average of XYZ returns Expected XYZ return = [0.25+0.05+(-0.05)+0.15+(-0.10)+0.30 ]/6 =0.10 (D) Co variance of the return for XYZ with return on the market Year Return of XYZ Expected return of XYZ (A)      Return of XYZ - Expected return (B)      Market return - expected return (A) X (B) 1999 0.25 0.1 0.15 -0.05 -0.0075 1998 0.05 0.1 -0.05 0.15 -0.0075 1997 -0.05 0.1 -0.15 0.25 -0.0375 1996 0.15 0.1 0.05 0.05 0.0025 1995 -0.1 0.1 -0.2 0.3 -0.06 1994 0.3 0.1 0.2 -0.1 -0.02 Total -0.13 Co variance   =   Total of (A X B) / no of years = -0.13/6 =-0.021

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