Question

The following table shows estimates of the risk of two well-known Canadian stocks and their coefficient of determination (R²) to the market:

	Standard Deviation (%)	R2	Beta	Standard Error of Beta
Toronto Dominion Bank	17	.53	.89	.13
Loblaw	31	.04	.24	.24

a. What proportion of each stock’s risk was market risk, and what proportion was specific risk? (Do not round intermediate calculations. Enter your answers as a percent rounded to the nearest whole number.)

	Toronto Dominion Bank	Loblaw
Market risk	%	%
Specific risk	%	%

b. What is the variance of Toronto Dominion? What is the specific variance? (Use percents, not decimals, in your calculations. Do not round intermediate calculations. Round your answers to 2 decimal places.)

	Toronto Dominion Bank
Variance
Specific variance

c. What is the confidence interval on Loblaw's beta? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places. Enter the lowest value answer first and the highest value answer second in order to receive credit for correct answers.)

Confidence interval             % to %

d. If the CAPM is correct, what is the expected return on Toronto Dominion? Assume a risk-free interest rate of 3% and an expected market return of 10%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected return             %

e. Suppose that next year the market provides a zero return. Knowing this, what return would you expect from Toronto Dominion? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected return             %

Answer 1

a. What proportion of each stock’s risk was market risk, and what proportion was specific risk? (Do not round intermediate calculations. Enter your answers as a percent rounded to the nearest whole number.)

The R² value measures the proportion of risk on account of market. And hence, 1 - R² will the proportion of specific risk. Hence, your final answer will be as shown in the table below:

	Toronto Dominion Bank	Loblaw
Market risk	53%	4%
Specific risk	47%	96%

b. What is the variance of Toronto Dominion? What is the specific variance? (Use percents, not decimals, in your calculations. Do not round intermediate calculations. Round your answers to 2 decimal places.)

Variance = (Std deviation)² = 17² = 289

Specific variance = Proportion of specific risk x Variance = 47% x 289 = 135.83

Hence your answers are:

	Toronto Dominion Bank
Variance	289
Specific variance	135.83

c. What is the confidence interval on Loblaw's beta? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Round your answers to 2 decimal places. Enter the lowest value answer first and the highest value answer second in order to receive credit for correct answers.)

For Loblaw's beta, the t statistics = Beta / Standard error in beta = 0.24 / 0.24 = 1

This is significant at 90% confidence interval

d. If the CAPM is correct, what is the expected return on Toronto Dominion? Assume a risk-free interest rate of 3% and an expected market return of 10%. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected return = risk free rate + Beta x (Expected market return - risk free rate) = 3% + 0.89 x (10% - 3%) = 9.23%

Expected return 9.23 %

e. Suppose that next year the market provides a zero return. Knowing this, what return would you expect from Toronto Dominion? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Expected return = risk free rate + Beta x (Expected market return - risk free rate) = 3% + 0.89 x (0% - 3%) = 0.33%

Expected return 0.33%