1. CAPM and Multifactor Models (18 points) Consider the following Fama-French (FF) three factor model: ro-r; = ap + BD (M-1) + Bsmelsme+BHML'HML +ep, where a security D's monthly excess return is regressed on three benchmark factors. The regression output is (numbers in the parentheses are standard errors): Regression output Estimate 0.83 Correlation coefficient R-square 0.68 Residual SD = Regression SE %) 5.33 Alpha = Intercept (%) 0.19 (0.68) Market beta 1.34 (0.18) SMB (size) beta -1.11 (0.31) HML (book to market) beta 0.19 (0.28) a) Based on the estimated alpha, does the FF model hold? Perform hypothesis testing to answer this question. (Hint: Suppose a t-statistic of 2.0 corresponds to a p-value of 5%. You may want to use this t-statistic cutoff to make the decision.) (9 points) b) Suppose the model is true. The T-bill rate is 2%. We forecast the market return (rm) to be 8%, the size portfolio return (TMB) to be 3%, and the book-to-market portfolio return (THML) to be 4% for the next month. What is the model implied expected return for security D for the next month? (9 points) 1. CAPM and Multifactor Models (18 points) Consider the following Fama-French (FF) three factor model: ro-r; = ap + BD (M-1) + Bsmelsme+BHML'HML +ep, where a security D's monthly excess return is regressed on three benchmark factors. The regression output is (numbers in the parentheses are standard errors): Regression output Estimate 0.83 Correlation coefficient R-square 0.68 Residual SD = Regression SE %) 5.33 Alpha = Intercept (%) 0.19 (0.68) Market beta 1.34 (0.18) SMB (size) beta -1.11 (0.31) HML (book to market) beta 0.19 (0.28) a) Based on the estimated alpha, does the FF model hold? Perform hypothesis testing to answer this question. (Hint: Suppose a t-statistic of 2.0 corresponds to a p-value of 5%. You may want to use this t-statistic cutoff to make the decision.) (9 points) b) Suppose the model is true. The T-bill rate is 2%. We forecast the market return (rm) to be 8%, the size portfolio return (TMB) to be 3%, and the book-to-market portfolio return (THML) to be 4% for the next month. What is the model implied expected return for security D for the next month? (9 points)