Problem 1) What is the average annual (historic) return on the hedge fund? Note the returns are reported monthly. Multiply by 12 to annual returns. Need to answer with annual returns. Answer should go to 1 place behind decimal (ie: 10% expressed as 10.0)
Problem 2) What is the average (historic) return on the stock market? Note the returns are reported monthly. Need to answer with annual returns. Answer should be as above (ie: 10% expressed as 10.0)
Problem 3) What is the average (historic) return on the risk-free asset. Note the returns are reported monthly. Need to answer with annual returns. Answer should be as above (ie: 10% expressed as 10.0)
Problem 4) What is the annualized standard deviation of the hedge fund return? Note the returns are reported monthly. Need to answer with annual standard deviation. Use excel function: STDEVP( ).
Problem 5) What is the annualized standard deviation of the stock market return?
Problem 6) What is the annualized standard deviation of the risk-free return?
Problem 7) Given that investors like expected return and dislike risk, if standard deviation of return was the correct measure of risk, which of 3 assets would you expect investors to choose? Choose 1.
Problem 8) Run following regression in excel for the hedge fund returns:
Risk (Hedge Fund) - Risk (Risk-Free) = Theta + Beta(Risk(market) - Risk(risk-free)) + Idiosyncratic
Problem 9) The stock market was up 2.27% in February, 2005. Given your CAPM regression how did the hedge fund perform?
Problem 10) What is the annualized theta? Express it as a percent to 1 decimal (ie: if the annualized theta was 1% enter your answer as 1.0. In an efficient market and a world without noise, it will be zero. In practice theta is not zero because of noise in the data, because money managers are incompetent (negative theta).
Problem 11) Given your CAPM estimates, what fraction of your financial assets would you allocate to the hedge fund, if you were able to invest in it? Remember, it is an exclusive fund and it not open to all investors. You will get credit for any reasonable answer.
Attachment:- CAPM worksheet.rar