27. Based on the correlation that Li’s team believes to exist between the CCIRP and TELIRP, the
new volatility for the SCIRP is closest to:
A. 31.8%.
B. 49.1%.
C. 56.4%.
Answer = C
“Capital Market Expectations,” John P. Calverley, Alan M. Meder, Brian D. Singer, and Renato
Staub
2013 Modular Level III, Vol. 3, Reading 18, Section 3.1.1.4
Study Session 6–18–c
Demonstrate the application of formal tools for setting capital market expectations, including
statistical tools, discounted cash flow models, the risk premium approach, and financial
equilibrium models.
C is correct. Based on Equation (3a) applied to a regression:
( )
( ) ( ) ( ) ( ) ( )
( )
Find the variance of the error term using values from Exhibit 2:
( ) ( ) ( )
( )
The adjustment is a correlation of 0.25.
Change the correlation into a covariance:
( ) ( ) ( ) ( )
( ) ( )
Apply the new covariance to Equation (3a) to find the new variance:
( ) ( )
The volatility of SCI after adjusting for the correlation is 56.4% = √ .
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