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Statistical Inference, Simple Regression Analysis) You have been asked by your client to recommend which of two available stocks will perform better over time, relative to risk. You will need to compare risk and return relationship of the two stocks over time and present your findings as a formal written report (detailing your calculations and findings).

The goal of this assignment is to give you practice in performing the different types of quantitative analysis tasks often undertaken by Business graduates.

provide you with feedback on your ability to carry out such tasks, and learn how and when to use different quantitative techniques covered in the last six (6) modules of the subject. This is an individual assignment, worth 20% of the total assessment in this subject. This assignment is based on topics including; Sampling and Estimation, Hypothesis Testing, and Regression Analysis. Use the marking rubric as a guide when working on your assignment.

Download the data for S&P 500 index, Boeing Stock Price, General Dynamics Corp. Stock Price, and US TN (10 Year), using the links provided above and choosing Monthly Historical Data for all variables covering the period related to a group your Student ID belongs to.Example: Suppose a student's IDThis ID falls in an interval corresponding to group 06 and therefore, this student would download monthly data covering the period 01/10/2010 to 31/10/2015.

Calculate returns for these three series in Excel or any software of your choice using the transformation: rt = 100*ln(Pt / Pt-1) and perform the Jarque-Berra test of normally distributed returns for each of Boeing and GD. What do you infer about the distribution of the two stock returns series Describe also the risk and average return relationship in each of

We have performed a similar task in Workshop 01.

Test for normality of variable has been performed through Jarque- Berra Test. The respective test statistics is known as JB stat and the relevant formula to find the JB stat is highlighted below.

Step 1:  Null and alternative hypotheses

H0: Returns of variable is normally distributed.

H1: Returns of variable is not normally distributed.

Step 2: JB stat

The JB stat has been computed in excel with the help of description statistics and the final table represents the value of JB stat.

Step 3: Compare with applicable critical value

It can be concluded from JB stat table that for Boeing Returns the JB stat value is significantly lesser than the critical value which represents that null hypothesis would not be taken for rejection. Thus, Boeing returns are considered to be normally distributed. It can be concluded from JB stat table that for General Dynamics Returns the JB stat value is significantly greater than the critical value which represents that null hypothesis would not be taken for rejection and alternative hypothesis would be taken for acceptance. Thus, General Dynamics Returns cannot be considered to be normally distributed.

• Average General Dynamics Returns differs from 2.8% (hypothesis claim)

Step 1: Null and alternative hypotheses

H0: Average General Dynamics Returns is not considered to be different than 2.8%

H1: Average General Dynamics Returns is considered to be different than 2.8%

Step 2: t statistics (z stat would not be used because the population standard deviation is not given)

Step 3: Degree of freedom

Total number of data points = 60

Degree of freedom = Total number of data points-1 = 59

Step 4: The p value

The p value would be taken here would be two tailed value because the hypothesis test is a two tailed test.

Inputs: t stat =-3.0279, df =59

The p value = 0.003658

Step 5: Assumption for significance level

Let the significance level = 5%

Step 6: Compare p value with significance level

It can be concluded from above that p value is significantly lower than significance level which represents that null hypothesis would be rejected and alternative hypothesis would be accepted. Thus, average General Dynamics Returns is considered to be different than 2.8%

• Risk for Boeing Returns and General Dynamics Returns is different. (hypothesis claim)

Step 1: Null and alternative hypotheses

H0: Risk for Boeing Returns and General Dynamics Returns is not different.

H1: Risk for Boeing Returns and General Dynamics Returns is different.

Step 2: F stat

F stat = 1.5592

Step 3: The p value

The p value would be taken here would be two tailed value because the hypothesis test is a two tailed test.

The p value = 2 times of one tailed value = (2*0.0453) = 0.09067

Step 4: Assumption for significance level

Let the significance level = 5%

Step 5: Compare p value with significance level

It can be concluded from above that p value is significantly higher than significance level which represents that null hypothesis would not be rejected and alternative hypothesis would be not accepted. Thus, risk for Boeing Returns and General Dynamics Returns is not different.

• Returns for Boeing Returns and General Dynamics Returns are different. (Hypothesis claim)

Step 1: Null and alternative hypotheses

H0: Returns for Boeing Returns and General Dynamics Returns are not different.

H1: Returns for Boeing Returns and General Dynamics Returns are different.

Step 2: two sample t stat

t stat = 0.0011

Step 3: The p value

The p value would be taken here would be two tailed value because the hypothesis test is a two tailed test.

The p value = 0.9991

Step 4: Assumption for significance level

Let the significance level = 5%

Step 5: Compare p value with significance level

It can be concluded from above that p value is significantly higher than significance level which represents that null hypothesis would not be rejected and alternative hypothesis would be not accepted. Thus, returns for Boeing Returns and General Dynamics Returns are not different.

The population risk and return of the two stocks i.e. Boeing and General Dynamics (GD) do not tend to differ in any significant manner as is apparent from the hypothesis test deployed above. In such circumstance, the only potential option is to rely on the sample statistics with regards to return and risk.  Boeing stock has higher sample returns but the same is achieved at higher risk. The preferred stock choice would be GD owing to the higher return per unit risk in the sample selected.

(5) The excess return computation has been performed by deduction of risk free rate (indicated by treasury yields). The CAPM model computation has been henceforth performed on the basis of linear regression analysis. The excess market return (S&P index used as proxy) serves as the predictor variable for estimation of the excess stock return (General Dynamics).

The requisite equation would be captured as stated below.

GD stock excess returns = -0.08 + 0.836*Excess returns on market

(c) R2 = 0.3808

(d) The GD stock beta had a 95% confidence interval in the range (0.556,1.116).

(6) Hypothesis Testing

H0: β = 0 indicating stock beta is insignificant.

H1: β ≠ 0 indicating stock beta is significant.

For hypothesis testing using confidence interval, the key decision rule is that the underlying null hypothesis can be rejected only when the value hypothesised does not fall in the confidence interval. The value hypothesised is 1 which is present in the confidence interval. Hence, no rejection of null hypothesis can happen.

(7) Test for normality of variable has been performed through Jarque- Berra Test. The respective test statistics is known as JB stat and the relevant formula to find the JB stat is highlighted below.

Step 1:  Null and alternative hypotheses

H0: Returns of variable is normally distributed.

H1: Returns of variable is not normally distributed.

Step 2: JB stat

The JB stat has been computed in excel with the help of description statistics and has come out as 23.81

Step 3: It is evident that the above computed JB statistic is higher than the critical value and hence rejection of null hypothesis is caused.

(1) In line with the inferential testing, it would be appropriate to conclude that normality is observed for stock monthly returns of Boeing stock while non-normality is observed for stock monthly returns of General Dynamic stock.

In relation to stock, two pivotal characteristics are relates risk (represented by standard deviation) and returns. This is in line with the theoretical underpinning whereby for an investment with higher risk, a higher return in expected. For the sample period stock returns, Boeing tend to have a higher average returns than GD but the associated risk is also higher for Boeing.

(2) For the null hypothesis, the relevant distribution would be student T considering the fact that the population standard deviation is unknown. Further, the relevant hypothesis testing indicates that average returns on GD stock are significantly deviant from 2.8%.

(3) The population variances for the monthly stocks returns of Boeing and GD are not different and can be assumed to be same.

(4) The population returns for the monthly stocks returns of Boeing and GD are not different and can be assumed to be same. GD emerges as the preferable stock on back of sample characteristics.

(5) (b) The GD stock as per CAPM is 0.836. This is indicative of the fact that as there is a change in the excess returns on market index by 1%, there is corresponding 0.836% change in the excess returns on GD stock.

(c) The R2 value can be interpreted as the given predictor variation i.e. excess returns on market provides explanation for a paltry 28.08% of the changes in excess returns on GD stock and the remaining variation is not explained by the given model.

(d) The GD stock beta would lie between 0.556 and 0.116 with a 95% chance.

(6) The beta of the GD stock does not vary significantly from 1 based on the confidence interval related hypothesis testing and hence it is correct to assume this as a neutral stock.

(7) The normality of residuals is not satisfied for the CAPM model as the relevant hypothesis test indicates non-normal distribution.

Cite This Work

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