Benchmark: S&P 500

Question 1

What is the law of large numbers?

Answer 1

• The law of large numbers states that the average of a large sample will be close to the true population average and that it will get closer the larger the sample.
• The law of large numbers does not guarantee that a given sample, especially a small sample, will reflect the true population characteristics or that a sample which does not reflect the true population will be balanced by a subsequent sample.
• In business, the term “law of large numbers” is sometimes used in a different sense to express the relationship between scale and growth rates. !
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Question 2

What is the Beta of a stock?

Answer 2

Measure of how a stock relates to the market. It is the slope of a line.

Question 3

What does it mean if Beta of a stock is 1?

Answer 3

It means it follows the market.

Question 4

What does it mean if Beta of a stock is greater than 1?

Answer 4

It means the stock overreacts to the market, ie, if the market is down or up, then it’s really bad or good for the stock

Question 5

In terms of relating a stock to the market by a regression line, what do the various parts of the line equation mean?

Answer 5

y=mx + B

Y= return on the stock (eg, Apple)
X= market return (eg, S&P 500)
M= Beta, or relation of stock to market; which is a measure of risk.
B= Alpha, a measure of how well the stock returned relative to the market, eg, 0 alpha means it returned what the market returned, negative means it did poorly, positive means out-performance

Question 6

When would the law of large numbers work?

Answer 6

If each member of the population were independent and each added member were tested to be independent

Question 7

Why does the law of large numbers fail for the S&P 500?

Answer 7

Because there is interdependence among the stocks

Question 8

What is idiosyncratic risk?

Answer 8

The risk that a point on a regression line running through a population for a given stock will lie above or below the line through the total market