Solved: You have just run a regression of monthly returns

on

You have just run a regression of monthly returns on MAD, a newspaper and magazine
publisher, against returns on the S&P 500, and arrived at the following result:

RMAD = ?0.05% + 1.20 RS&P

The regression has an R2 of 22%. The current Treasure bill rate is 5.5% and the current
Treasure bond rate is 6.5%. The risk-free rate during the period of the regression was 6%.
Answer the following questions relating to the regression:

a. Based on the intercept, you can conclude that the stock did

i. 0.05%worsethanexpectedonamonthlybasis, during the regression.

ii. 0.05% better than expected on a monthly basis during the period of the regression.

iii. 1.25% better than expected on a monthly basis during the period of the regression.

iv. 1.25% worse than expected on a monthly basis during the period of the regression.

v. None of the above.

b. You now realize that MAD went through a major restructuring at the end of last month (which
was the last month of your regression), and made the following changes:

• The firm sold off its magazine division, which had an unlevered beta of 0.6, for $20 million.

• It borrowed an additional $20 million and bought back stock worth $40 million.

After the sale of the division and the share repurchase, MAD had $40 million in debt and $120
million in equity outstanding. If the firm’s tax rate is 40%, re-estimate the beta after these
changes.

You have just run a regression of monthly returns on

ANSWER
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