You are a financial analyst for WillyP Financial. You have collected the past mo

Question

You are a financial analyst for WillyP Financial. You have collected the past monthly stock price movements for Intel and Microsoft stocks. Your analysis has produced the following estimates for Intel: = 3.5% and = 1. 6 and for Microsoft: = 2.5% and = 1. 3. Suppose the market index subsequently rises by 10% in one month and Intel’s stock price increases by 20% and Microsoft’s stock price increases 22%, what are the abnormal returns in Intels’ and Microsoft’s stock prices?
Please choose all correct answers. Please note that each incorrect answer will reduce the score by 10%.

Explanation / Answer

Solution:

We have following Data

Intel: = 3.5% and = 1. 6 and for Microsoft: = 2.5% and = 1. 3

Alpha is excess return on an investment relative to the return on a benchmark index

Beta is systematic risk that defines how the stock price will move as compared to the benchmark index.

Given that Market has increased by 10%, so based on beta we can say that share price

Intel should increase by 10% *1.6 =16%

Microsoft should increase by 10% *1.3 =13%

We have alpha values for both the stocks so expected return should be

Intel : 16% +3.5% = 19.5%

Microsoft : 13% +2.5% = 15.5%

Abnormal Return = Actual return - Expected Return

Actual return is 20% for Intel and 22% for Microsoft

Abnormal returns for these two stocks are

Intel = 20% -19.5% = 0.5%

Microsoft = 22% - 15.5% = 6.5%

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