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Case details
1) Jan 1991 - BMC had $25 mn.AUM.
2) BMC's satted goals were to enhance returns but reduce risks for clients via market timing.
3) BMC kept a majority of funds in no-load low-expense index funds with the balance in money market instruments.
BMC used Vanguard's Index 500 Trust due to its extremely low expense ratio and its success at closely matching the retu
4) As of Jan 4, 1991 BMC had 79.2% of $25 mn invested in Vanguard fund.
5) New year resolution was to look for some individual stocks for possible purchase for MC's equity portfolio. Focus was o
proportion of equities as the market was still a good value.
6) BMC considering two NYSE-listed companies, California REIT and Brown Group since their prices seemed unreasonabl
7) california REIT was an extremely volatile stock and price was $2.25 as on Jan 4, 1991.
8) Brown Group stock price seemed quite variable and price was $24 as on Jan 4, 1991.
Exhibits
1) Investment return data
2) Monthly returns of California REIT vs S&P 500 Index Fund
3) Monthly returns of Brown Group Inc. vs S&P 500 Index Fund
Case questions
1) Calculate the standard deviation of stock returns of California REIT and Brown Group during the past 2 years.
How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest?
2) Suppose Beta's position had been 99% of equity funds invested in the Index fund and 1% in the individual stock. Calcu
using each stock. How does each stock affect the variability of the equity investment, and which stock is riskiest?
Explain how this makes sense in view of your answer to Q1 above.
3) Perform a regression of each stocl's monthly returns on the index returns to compute the beta for each stock.
How does this relate to the situation described in Q2 above?
4) How might the expected return for each stock relate to its riskiness?
y market instruments.
closely matching the return on the S&P 500 Index.
Q1 Calculate the standard deviation of stock returns of California REIT and Brown Group during the past 2 years.
How variable are they compared with Vanguard Index 500 Trust? Which stock appears to be riskiest?
The figures are as shown above. CAL REIT is riskiest.
Q2 Suppose Beta's position had been 99% of equity funds invested in the Index fund and 1% in the individual stock. Calcu
using each stock. How does each stock affect the variability of the equity investment, and which stock is riskiest?
Explain how this makes sense in view of your answer to Q1 above.
The portfolio total risk figures are as shown above.
Portfolio risk reduces with CAL REIT but increases with Brown vis-à-vis 100% VG index due higher correlation with BG. BG
Q3 Perform a regression of each stock's monthly returns on the index returns to compute the beta for each stock.
How does this relate to the situation described in Q2 above?
Beta figures are as shown above.
Q4 How might the expected return for each stock relate to its riskiness?
CAL REIT return is on account of low sys risk but high unsys risk.
BG return is on account of near equal amounts of sys and unsys risks.
99% VG + 1% BG
7.34%
-2.44%
2.23%
5.15%
3.99%
-0.59%
8.94%
1.84%
-0.38%
-2.39%
1.89%
2.34%
-6.80%
1.33%
2.60%
-2.48%
9.72%
-0.65%
-0.29%
-9.09%
-4.86%
-0.53%
6.55%
2.61%
4.614%
Portfolio Standard
4.568%
Deviation
Portfolio Standard
4.614%
Deviation
Solution 3 - Calculation of β
Regression of California REIT Returns on Market Index Returns (Vanguard Index 500 Trust)
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.0735316602
R Square 0.005406905
Adjusted R Square -0.039801872
Standard Error 0.0941264386
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.001059618 0.001059618 0.1195986 0.7327555022
Residual 22 0.194915302 0.008859786
Total 23 0.19597492
Standard Upper
Coefficients t Stat P-value Lower 95%
Error 95%
Intercept -0.0242787162 0.019779398 -1.22747496 0.232617 -0.0652986777 0.0167412
Vanguard Index 0.1473514325 0.426080217 0.345830261 0.7327555 -0.7362848548 1.0309877
500 Trust
RESIDUAL OUTPUT
Predicted
Observation Residuals
California REIT Scatter Plot and Regression Line of
1 -0.0134925913 -0.26910741
Regression of Brown Group Returns on Market Index (Vanguard Index 500 Trust) Returns
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.6561697663
R Square 0.4305587622
Adjusted R Square 0.4046750696
Standard Error 0.0630126029
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.066048208 0.066048208 16.634364 0.0004980217
Residual 22 0.087352939 0.003970588
Total 23 0.153401146
Standard Upper
Coefficients t Stat P-value Lower 95%
Error 95%
Intercept -0.0195384298 0.013241246 -1.47557331 0.1542282 -0.0469990942 0.0079222
Vanguard Index
1.1633496457 0.285237856 4.078524721 0.000498 0.5718025389 1.7548968
500 Trust
RESIDUAL OUTPUT
Predicted Brown
Observation Residuals
Group Scatter Plot and Regression Line
1 0.0656187642 0.025981236
20.00%
-0.736285 1.0309877
t and Regression Line of Cal REIT Returns Vs. Market Index Returns
20.00%
15.00%
10.00%
5.00%
0.00%
-4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% California REIT
-5.00% Predicted California REIT
Linear (Predicted California REIT)
-10.00%
-15.00%
-20.00%
-25.00%
-30.00%
Lower Upper
95.0% 95.0%
-0.046999 0.0079222
0.5718025 1.7548968
Plot and Regression Line of Brown Group Returns Vs. Index Returns
20.00%
15.00%
10.00%
5.00%
0.00%
% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% Brown Group
-5.00% Predicted Brown Group
Linear (Predicted Brown Group)
-10.00%
-15.00%
-20.00%
-25.00%
-30.00%
This nearly equals the regression This nearly equals the regression
beta (0.15) for California REIT beta (1.16) for Brown Group
computed in solution to problem 3 computed in solution to problem 3
Change in Variability / Risk
Sarah's Initial Invetsment: 99% in Vanguard Index 500
Risk Before the Investment = 4.560%
Risk After the additional 1% Investment in following securities: