QUESTIONS 25 TO 30 RELATE TO PERFORMANCE ATTRIBUTION MINGLU LI CASE SC...

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% = √ .