If the market index subsequently rises by 8% and Fords stock price rises by 7% what is the

QUESTION

An index model regression applied to past monthly returns in Fords stock price produces the following estimates, which are believed to be stable over time:
rF=.10%+1.1rM
If the market index subsequently rises by 8% and Fords stock price rises by 7%, what is the abnormal change in Fords stock price?
Solution: Let assume price 100. Accordingly required return on Ford stock based on equation given above: rF=.10%+1.1rM = .10% + 1.1*8% = 8.90% But actual return on Ford stock is 7%, accordingly: Return % = Dollar return / Price 7% = 8.90 / Price Price = 127.14 Accordinly actual

se = 127.14 100 = 27.14 Normal price increase based on standard return based on equation = 108.90 100 = 8.90 Abnormal price change in Fords stock price= (27.14 8.90) / 100 = 18.24%

ANSWER:

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