FN585: Financial Modelling and Dealing

Task: to estimate the excess returns on a stock of your choice applying the Arbitrage Pricing
Theory (APT).

Aim: to evaluate your understanding of financial theory to transform data into correct form, to
model financial relationships and correctly interpret the findings. The analysis of the results is
the most important stage of the assignment. It involves estimating an initial model or models,
performing appropriate diagnostic tests, re-forming and re-estimating, and conducting tests of
hypothesis.

Format: The assignment consists of three parts comprising a written report of a maximum of
1,500 words. A pdf format of the report, including the EViews output in an Appendix, to be
uploaded via My Studies.

Presentation instructions:
1. Do not just cut and paste EViews output into your coursework, create your own tables
to fit your needs. However, all estimation results (from EViews) must be collected in an
Appendix and clearly referenced in the text (i.e., referring to a table or a graph number
in the Appendix).

2. You should consider including a comparative table of results (in terms of different
variables).

3. tabulate your results in the main draft, simply cutting and pasting EViews
output is not acceptable.

4. No marks will be awarded for output results without explanations.

5. Appropriate notation: numbers should be reported with up to 3 decimal points; use
Word equation editor if typing formulas; use uniform reference formatting (e.g.,
Chicago); use at least font size 11.

6. Do all hypothesis tests properly. For instance, the way you report the significance of a
coefficient reveals how well you understand hypothesis testing.
Specific instructions on performing the task:

PART 1: (25 marks)
1. Carefully explain the APT, outlining the mathematical model, underpinning it,
appropriately referenced. [8 marks]

2. Discuss, with reference to an empirical study, the applicability of APT for estimating
excess stock returns. note that there are no limitations on the year

2
publication. It can be a more recent study or a seminal work, but not the example
discussed in class. [8 marks]
3. Briefly, provide a background information on your chosen company. [2 marks]
4. Present and explain the model you will be estimating based on the APT, in the context
of your data. Your model should be of the form:
Yt =  + β1X1t + β2X2t + ut ut ~ N (0, σ2) [7 mark