ISOM5520 Statistics for Financial Analysis

Assignment01
Due date:

13th August, 2015 for L01

15th August, 2015 for L02

1. These data give monthly returns for stocks of three familiar companies: Disney, Exxon, and
McDonalds from January 1990 through December 2005. (Question01.xls)
(Excel Guide: P.80 Appendix 2.1 & P.144 Appendix 3.1)
(a) Describe and contrast histograms and boxplots of the three companies. Be sure to use
common axes to scale the histograms to make the comparison easier and more reliable.
(b) Find the mean, SD, and for each set of returns. Can these means and SDs be combined
with the empirical rule to summarize the distributions of these returns?
(c) What does comparison of the coefficients of variation tell you about these three stocks?
(d) Typically, stocks that generate high average returns also tend to be volatile, with larger
upward and downward swings in price. To get a higher average rate of return, an investor
has to tolerate more volatility. Is that true for these three stocks?

2. Dell, IBM, and Microsoft are well known in the computer industry. If the computer industry is
doing well, then we might expect the stocks of all three to increase in value. If the industry goes
down, wed expect all three to go down as well. How strong is the association among these three
companies? After all, they compete in same areas. For example, Dell and IBM both sell powerful
computer systems designed to be used as Web servers by Web sites like Amazon or
weather.com.
This data set has monthly returns for Dell, IBM, and Microsoft for January 1990 through

December 2006. The returns are calculated as = 1 . In this fraction, is the price of the
1

stock at the end of a month and 1 denotes the price at the end of the prior month. If multiplied
by 100, the return is the percentage change in the value of the stock during the month. The
returns given here have been adjusted for accounting activities (such as dividend payments and
splits) that would otherwise produce misleading results. The data are from the Center for
Research in Security Prices (CRSP), as are other stock returns used in this book.
(Question02.xls)
Motivation
(a)

Investors who buy stocks often buy several to avoid putting all their eggs into one basket.
Why would someone who buys stocks care whether the returns for these stocks were
related to each other?

(b)

Would investors who are concerned about putting all their eggs into one basket prefer to
but stocks that are positively related, unrelated, or negatively related?

Method
(c)

How can an investor use correlations to determine whether these three stocks are related
to each other? How many correlations are needed?

(d)

Correlations can be fooled by patterns that are not linear or distorted by outliers that do
not conform to the usual pattern. Before using correlations, how can the investor check
the conditions needed for using a correlation?

Mechanics
(e)

Obtain all of the scatterplots needed to see whether there are patterns that relate the
returns of these stocks. (A scatterplot matrix works nicely for this if your software
provides one.) Does it matter which shock return goes on the x-axis and which goes on
the y-axis? Do you find that the returns are associated? Is any association linear?

(f)

Obtain all of the correlations among these three stocks.

Message
(g)

Summarize your analysis of the relationships among these returns for an investor who is
thinking of buying these stocks. Be sure to talk about stocks, not correlations.

3.(a)

Find the VaR for an investment of $500,000 at 1%. (That is, find out how low the value
of this investment could be if we rule out the worst 1% of outcomes.) The investment is
expected to grow during the year be 10% with SD 35%. Assume a normal model for the
change in value.

(b) How much smaller would the annual SD of the investment need to become in order to
reduce the VaR to $200,000? Assume that the expected growth remains 10%.
(c) If this performance is expected to continue for two years, what is the VaR (at 1%) if the
investment is held for two years rather than one? Use the features of the investment in
part (a)?

4. Whole Foods is an all-natural grocery chain that has 50,000 square foot stores, up from the
industry average of 34,000 square feet. Sales per square foot of supermarkets average just under
$400 per square foot, as reported by USA Today in an article on A whole new ballgame in
grocery shopping. Suppose that sales per square foot in the most recent fiscal year are recorded
for a random sample of 10 Whole Foods supermarkets.
(a) The data (sales dollars per square foot) are as follows: 854, 858, 801, 892, 849, 807, 894,
863, 829, 815. Using the fact that = 846.2 and = 32.866, find a 95 percent
confidence interval for the population mean sales dollars per square foot for all Whole
Foods supermarkets during the most recent fiscal year. Are we 95 percent confident that
this mean is greater than $800, the historical average for Whole Foods?
(b) Regard the sample of 10 sales figure for which = 32.866 as a preliminary sample.
How large a sample of sales figures is needed to make us 95 percent confident that , the
sample mean sales dollars per square foot, is within a margin of error of $10 of , the
population mean sales dollars per square foot for all Whole Foods supermarkets.