Question Two (30 marks)
You have just finished your postgraduate studies and secured a job with a well-known fund manager. Before you start work, you are keen to learn whether (i) the CAPM works in practice, and (ii) if a portfolio diversified across industries offers any benefit over one diversified within a given industry. Use the monthly returns for 48 industry portfolios, the excess return on a broad market index and the one-month (risk-free) treasury bill rates provided on Wattle in the Excel spreadsheet entitled “Assignment Data.xlsx” to investigate these issues. Specifically:
a. Use this data to estimate each portfolio’s security characteristic line (“SCL”) and, in doing so, obtain an estimate of its true beta coefficient;
b. Use the findings from a. to estimate and plot the Security Market Line (“SML”); and,
c. Formally test whether your results lend support to the Sharpe-Lintner CAPM.
Present your findings, including graphs where useful, in a written report comprising only the following sections:
Introduction: The introduction should state the aims of your report as well as overview the theoretical strengths and weaknesses of the CAPM;
Data and Methods: This section should include a description of the data, provide descriptive statistics, summarise your methodological approach and detail any formulas used in your report;
Results: The results section should include statistics, tables and graphs that are relevant to your investigations;
Conclusions: This section should see you interpret your results and conclude whether they are consistent with (i) the CAPM holding in practice, and (ii) the existence of any benefits to diversifying across industries rather than within a given industry. It should also include a brief discussion of any inherent weaknesses your data, models and test may have, how these issues could be circumvented and, where possible, whether or not your results are consistent with those documented in the
extant literature; and,
References: This section should include the bibliographic references of any studies cited in the course of your report.
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