Econ 136: Financial Economics

Problem Set #1 Due Date: February 5, 2014 Please write down the main functions (Excel or other) used. Please submit the homework before the class starts. Late homework will not be accepted. Please put your name, student ID & your GSIs name at the up right corner of the front page. Please staple the pages of your homework together. Homework will be returned in sections. 1. The return prole and risk of the S&P 500. In this exercise you will reproduce the graphs presented in class. The goal of this exercise is (i) to expand your datahandling skills, (ii) test your understanding of basic probability concepts using real data and (iii) develop an appreciation for the use of replicating a result to ensure that we understand it. Go to Yahoo Finance (nance.yahoo.com) and search for the ticker symbol SPY. On the left-hand side of the page you will see a link to Historical Prices. Click on the link to get to the Historical Prices page and download the daily prices from 02/01/93 to 01/24/14. You will nd a Download to Spreadsheet link at the bottom of the page. Also download the dividends for this period (the dividends are in a separate le). (a) Create a graph of the Close price of SPY (not the adjusted close price) as a function of time. Label the axes and give it a title (e.g. SPY). This is simply a graph using the data you have downloaded. (b) Create a graph of the SPY returns as a function of time using the Close price and dividends. Begin by adding a dividends column to assign dividends for each date: VLOOKUP() may be helpful here. For dates with no dividends, a #N/A will likely appear. You can eliminate the #N/A with the IF() and ISNA() functions. In the next column calculate the returns including the dividends. Graph these results. Label the graph. (c) Create a graph of the cumulative distribution function (CDF and 1 CDF) of the SPY returns. Copy the values return data to the next column using the Copy & Paste Special commands so that on the return values are copied. Order the returns using the Sort command. In the column to the where k right of the ordered returns calculate the CDF using CDF(xk ) = (Nk +1) is the running index of the return k = 1 . . . N and N is the number of returns. The COUNT() function is useful for calculating k . In the column to the right of your CDF results, use the IF() statement to create a column of CFD and 1-CDF depending on whether the return is negative. Graph these results with a linear x-axis and a logarithmic y-axis. Label the graph. 1

(d) Add a Gaussian distribution to the graph of the CDF of the SPY returns. Begin by calculating the mean AVERAGE() and standard deviation SQRT(VAR()) of the ordered returns. Highlight these in your homework so your GSI can see them. Use them to calculate the cumulative Gaussian distribution (NORMDIST() and 1 - NORMDIST()) in the column next to your last cumulative distribution calculation. Make a copy of the graph from the part (1c) above and add the cumulative Gaussian distribution to the copy. 2. The return prole and risk of the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD). In this exercise you will generate the graphs presented in class for a bond index. You will use the infrastructure you developed above in problem (1) for this exercise: the only dierence is the data. Each part of the exercise is a repeat of what we did above with the SPY data. Go to Yahoo Finance (nance.yahoo.com) and search for the ticker symbol LQD. On the left-hand side of the page you will see a link to Historical Prices. Click on the link to get to the Historical Prices page and download the daily prices from 07/31/02 to 01/24/14. Also download the dividends for this period (the dividends are in a separate le). (a) Create a graph of the Close price of LQD as a function of time. Label the axes and give it a title (e.g. LQD). This is simply a graph using the data you have downloaded. (b) Create a graph of the LQD returns as a function of time using the Close price and dividends. (c) Create a graph of the CDF of the LQD returns. (d) Add a Gaussian distribution to the graph of the CDF of the LQD returns 3. Risk Analysis: (a) Compare the time-series of return shown in the graphs generated above in items (1b) and (2b). State which index is riskier and explain why? (b) Compare the cumulative distribution functions shown in the graphs generated above in items (1d) and (2d). State which index is riskier and explain why? 4. Return Estimate: If you account is down 15%, what rate of return over the next year do you need to achieve to break even (i.e. make back the 15% you lost)? Assume the rate of ination is zero.