This problem illustrates how beta coefficients are estimated and uses material covered in the appendix to this chapter. It may be answered using any program that performs linear regression analysis, (e.g., Excel) or the beta calculation in the Investment Analysis programs. The following information is given:

a) Using regression analysis, compute the estimated equations relating the return on stock X to the return on the market and the return on stock Y to the return on the market. According to the equations, what is each stock's beta coefficient? What does each beta coefficient imply about the systematic risk associated with each stock?
b) What is the difference between the return on each stock given by the estimated equation for period 10 and the actual return? What may account for any differences in the estimated return and the actual return? (To answer this question, use the estimated equation, and compare the results with the actual results.)
c) What is the R2 for each equation? Interpret the R2. What does the R2 imply about the other sources of risk as they apply to stocks X and Y?

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