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Assignment 1

Complete Assignment 1 after you have read the required textbook chapters and online journal articles and worked through the online course materials for Lessons 1 to 3. Assignment 1 is worth a total of 100 marks and represents 10% of your final grade for FNCE 405. It consists of two parts; the first part constitutes 60% and the second part constitutes 40% of the assignment grade.

Part 1 (60 marks total)

Perform all of the steps listed below to complete this part. Use either complete sentences or point-form answers in your responses; just be sure your meaning is clear.

Perform all of the steps listed below to complete this part. Use either complete sentences or point-form answers in your responses; just be sure your meaning is clear.

Step 1: Choose one of the following dual-listed stocks (on the TSE and NYSE) and collect daily common stock adjusted closing price data on the stock from both the TSE and the NYSE for one calendar year:

Canadian National Railway Company

Royal Bank of Canada

Barrick Gold Corp.

Enerplus Resources Fund

Domtar Inc.

Gildan Activewear Inc.

Nortel Networks Corporation

Suncor Energy Inc.

BCE Inc.

Step 2: Gather the following market data sets for the same calendar year:

Government of Canada issued 3-month T-Bill daily rates

US federally issued 3-month T-Bill daily rates

Daily adjusted closing values on S&P/TSX Index

Daily adjusted closing values on S&P 500 Index

Step 3 Answer each of the following questions:

1. Look through your data sets to ensure that there are no missing data points. If you find missing data points, either use the simple interpolation method (i.e., ) to fill in the missing data, or delete the data point for all data sets. (Remember that, because there are different US and Canadian holidays, there may be days on which one or both markets are not open for business.) A good way to avoid any confusion is to determine the dates for your chosen stock in the TSE and NYSE , then use these dates to fill in missing data points or delete excess data points in the market data sets.

Discuss the method you have used to adjust your data sets, and how many data points have been added or deleted. Show the first five and last five data points of the six data sets you have obtained (i.e., two sets of company stock price data, two sets of risk-free rate data, and two sets of market index value data). (3 marks)

2. Use the adjusted closing stock prices and index values to calculate the daily returns in terms of the following:

Simple return: (Xt+1/Xt) – 1

Continuously compounded return: Ln(Xt+1/Xt)

As well, calculate the daily risk-free rates based on the Government of Canada and US Federal T-bill rates using this formula:

Daily risk-free rate = [(1 + Annual T-bill rate)^(1/365)] - 1

In your response, show the first five and last five data points of the simple and continuously compounded stock and index returns in the Canadian and US markets, as well as the daily Canadian and US risk-free rates you have calculated. (6 marks)

3. In EViews, regress the simple returns on the continuously compounded returns for the Canadian stock data. Set the constant intercept term to 0 by not including it in your regression equation.

Show the regression result you obtain. Explain the implicit assumption behind the regression model when we set the constant intercept term to 0. (3 marks)

4. Using the two hypothesis-testing methods described in Lesson 3, test the hypothesis that the two sets of Canadian returns are not significantly different from each other.

Show the steps you take to test the hypothesis, including the null hypothesis you define. For an example, refer to Activity 2 in the Lesson 3 course notes. Be sure to explain clearly and succinctly the conclusions you reach with regard to differences between simple returns and continuously compounded returns. Based on your conclusions, which set of Canadian stock returns (simple or continuously compounded) would you use to test the CAPM? (8 marks)

5. Use the Canadian stock return, risk-free rate, and index return datasets you chose in Question 4 above to estimate Jensen’s CAPM model with excess profitability, (Ri – Rf) = +(Rm – Rf) +ε, in the Canadian market for the security you have chosen. (Remember to change the risk-free rate if you used continuously compounded stock returns.) Apply the Test of Significance Approach to the following null hypotheses, then check your conclusions using the Confidence Interval Approach.

H0: = 0

H0: = 1

Display the regression result and show the steps you take to test the hypotheses. Interpret your results and report your conclusions regarding the level of excess profitability and the level of systematic risk for the stock in the Canadian market. (10 marks)

6. In EViews, regress the simple returns on the continuously compounded returns for the US stock data. Set the constant intercept term to 0 by not including it in your regression equation.

Show the regression result you obtain. (2 marks)

7. Using the two hypothesis-testing methods described in Lesson 3, test the hypothesis that the two sets of US returns are not significantly different from each other.

Show the steps you take to test the hypothesis, including the null hypothesis you define. Be sure to explain clearly and succinctly the conclusions you reach with regard to differences between simple returns and continuously compounded returns. Based on your conclusions, which set of US stock returns (simple or continuously compounded) would you use to test the CAPM? (8 marks)

8. Use the US stock return, risk-free rate, and index return datasets you chose in Question 7 above to estimate Jensen’s CAPM model with excess profitability, (Ri – Rf) = +(Rm – Rf) +ε, in the US market for the security you have chosen. (Remember to change the risk-free rate if you used continuously compounded stock returns.) Test the following null hypotheses:

H0: = 0

H0: = 1

Interpret your results and report your conclusions regarding the level of excess profitability and the level of systematic risk for the stock in the US market. (10 marks)

9. Are the estimated betas different in Questions 5 and 8 (i.e., in the Canadian versus the US market)? Elaborate your best theory on why this is so. (5 marks)

10. If there were a difference in the estimated betas between the Canadian and US markets, how would you go about testing whether this difference is persistent across time? (5 marks)

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