Financial Modeling
Fundamentals
Data Collection
Graphing
Rates of Return
Regression
CAPM
Rates of Return
Rates of Return
 Separate Tab
 Label it MarketModel
 Set up Titlebar and Titles
Financial Markets: A Practicum
Rule #4:
 Manage Sheets
Rule #6:
 Format for Ease
of Use
Rates of Return
 Relay 36 months
 Use the Range verification to check that you
have 36 months
=Data!A3
36R x 1C
=Data!A38
Financial Markets: A Practicum
Rule #1:
 Never enter the
same information
more than once.
© Oltheten & Waspi 2012
Rates of Return: Equity
 Adjust for dividends and splits
 Price t  Dividend t 
rt  
 1
Price t -1


 (Price t  Dividend
 Split Factor
t 1
rt  
Price t -1


Split Factor t
 Pt  Dividend
rt  
Pt 1

Financial Markets: A Practicum
t
*
t


 1


Split Factor t 
 1
Split Factor t 1 
© Oltheten & Waspi 2012
Rates of Return: Equity
 Adjust for dividends and splits
 Use either formula
 Verify results
 (Price t  Dividend
 Split Factor
t 1
rt  
Price t -1


Split Factor t
 Pt  Dividend
rt  
Pt 1

Financial Markets: A Practicum
t
*
t


 1


Split Factor t 
 1
Split Factor t 1 
© Oltheten & Waspi 2012
Rates of Return: Index
 The index has neither dividends nor splits
 Index t 
rt  
 1
 Index t -1 
Financial Markets: A Practicum
©&
Oltheten
& Waspi 2012
© Oltheten
Waspi 2012
Rates of Return: Risk Free
 Rates are already expressed as annual rates
 /12 to generate monthly data
 /100 to get mathematical equivalent
 1% = 0.01
Financial Markets: A Practicum
©&
Oltheten
& Waspi 2012
© Oltheten
Waspi 2012
Rates of Return
 Format
 Express as %
 Line up decimals
Rule #6:
 Format for Ease
of Use
 Reality check
 If you see a -63.32% at
least double check that
the stock did decline 63%
Financial Markets: A Practicum
Rule #13:
 Always verify
results
Market Model: Regression
The Market Model
 Estimates the degree to which returns on
the stock depend on returns to the market.
observed
rCompany,t  α  β rMar ket,t  et
Estimated using
observed
regression analysis
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Dynamic Regression
 Alpha = Intercept
Note the form of
the function
($B:$B, $C:$C)
(Company returns, Index Returns)
 Beta = Slope
($B:$B, $C:$C)
(Company returns, Index Returns)
Rule #5:
Make sure
that there
are no other
numbers in
columns B
or C
 Maintain Row &
Column discipline
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Regression Statistics
 Alpha
= Intercept ($B:$B,$C:$C)
 Beta
= Slope ($B:$B,$C:$C)
 Multiple R
= Correl ($B:$B,$C:$C)
 Standard Error
= Steyx ($B:$B,$C:$C)
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Names
 Name cells
Cell’s name is
H3
Rename the
cell RR
Reference the
cell by either
H3 or RR
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Names
 Assign names in the name box (under the
toolbar).
 This replaces the name H3 with RR. From
now on, anyplace you would use H3 you
can use RR instead.
RR
rr
RR
Financial Markets: A Practicum
fx
© Oltheten & Waspi 2012
Name Manager
 To see, edit, and manage names used in the
spreadsheet use Name Manager
 Ctrl+F3
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Dynamic Regression Statistics
 R Square = (Multiple R)2
 Name it RR
 Observations = Count($B:$B)
 Name it N
 Independent Variables: 2
 name it k
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Dynamic Regression Statistics
 k 1 
 Adjusted R Square  RR  
 * 1  RR
 Nk 
… from my
Econometrics Text Book
 H4 =RR-((k-1)/(N-k))*(1-RR)
is much easier to debug than
H4 = $H$3-(($H$7-1)/($H$6-$H$7)*(1-$H$3)
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Dynamic Regression Statistics
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Characteristic Line
Each marker is
one monthly
observation
Line
constructed
from calculated
alpha and beta
Y axis measures
returns on the
Equity of our
company
X axis measures
returns on the
Market
Financial Markets: A Practicum
Observations
 Generate observed values
 Titlebar J1:S1 and set J1=Data!A1
 Highlight B2:C38
 Generate XY scatter
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Observations
 January 2010 should be at -3.70%,16.30%
16.30%,-3.70%
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Observations
 Reset x and y axes
 [Chart Tools] [Design] [Select Data]
 Select Data and Edit
 Series name to Market Model!$B$2
 Series X values to Market Model!$C$3:$C$38
 Series Y values to Market Model!$B$3:$B$38
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Observations
 January 2010 should be at -3.70%,16.30%
-3.70%, 16.30%
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Observations
 Format to look professional




Remove gridlines and legend
Axis labels to 0 decimal places
Format markers
Set dynamic title = J1
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Observations
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Characteristic Line
 Use dynamic α and β to generate
characteristic line
(no trend lines!)
rCompany,t  α  β rMar ket,t  et
y=returns on
the company
Financial Markets: A Practicum
x = returns on
the index
© Oltheten & Waspi 2012
Observations
alpha=intercept
y=returns on
the company
Financial Markets: A Practicum
beta = slope
x = returns on
the index
© Oltheten & Waspi 2012
Characteristic Line
 Define the characteristic Line from the
minimum to the maximum index value.
= min(C:C)
= average(C:C)
= max(C:C)
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Characteristic Line
 Calculate the predicted company return.
= alpha + beta G15
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Characteristic Line
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Characteristic Line
 [Chart Menu][Design][Select Data]
 Add the three data points
 Format series to make it a line with no
markers
x = returns on
the index
Financial Markets: A Practicum
y=returns on
the company
© Oltheten & Waspi 2012
Reality Check
Maximum S&P: 10.77%
Minimum S&P: -8.20%
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Test
 Run the static regression using [Tools] [Data
Analysis] [Regression]
 Verify that the results match exactly
 Remove the static regression
 this is a test procedure, not part of the
deliverable.
Financial Markets: A Practicum
© Oltheten & Waspi 2012
Market Model