Entrepreneurial Finance Assignment 1
Entrepreneurial finance assignment 1
Problem 4.4.
Introduction
The CAPM model can be used to analyze the performance of a portfolio of investments. The model should be calculated by comparing the return of assets (Ri) minus the return of risk-free cash (Rf) of the fund against those numbers of a known index with historical data (Rm). With least-squares regression, a straight line has to be drawn through the points to finish the model. Alpha represents the point where the graph starts and beta the slope of the regression line. Alpha is the number that represents the fact of how well the fund did against the CAPM model. A positive alpha means the fund did better than CAPM predicted and negative the opposite. R² represents the ‘fit’ of the model, so how much of the data fits the straight line.
(a) Al thinks that the estimated alpha is too high because of survivor bias.
This concern is valid. This is due to several reasons. First, the R² presented is relatively low as the model fits only 32%. This means that 68% of the data is not explained by the model. Another point is the height of alpha. The monthly Sand Hill Index shows an average alpha in % per year of 4.92 at the significance level of 1, 5 and 10% level. The quarterly CA Index shows an alpha of 6.1 in % per year. According to the book ‘Venture capital and the Finance of Innovation (Wiley, 2010), these are lower and upper bounds of abnormal gross returns. The CA Index is considered an upper bound as the method of data collection of the Index is already considered having survivor bias. If we consider the fact that 5,73 and 6,1 are lower and upper bounds in the period of 1989 – 2008 plus given the fact that the financial crisis hit in 2008, the height of alpha = 7,5 could be considered as a concern. Furthermore, Largeco calculates their returns on the VC portfolio by adding the cash-flows and the reported company values from their funds. In the 10 years that Largeco operated (2006 – 2016), companies
Problem 4.4.
Introduction
The CAPM model can be used to analyze the performance of a portfolio of investments. The model should be calculated by comparing the return of assets (Ri) minus the return of risk-free cash (Rf) of the fund against those numbers of a known index with historical data (Rm). With least-squares regression, a straight line has to be drawn through the points to finish the model. Alpha represents the point where the graph starts and beta the slope of the regression line. Alpha is the number that represents the fact of how well the fund did against the CAPM model. A positive alpha means the fund did better than CAPM predicted and negative the opposite. R² represents the ‘fit’ of the model, so how much of the data fits the straight line.
(a) Al thinks that the estimated alpha is too high because of survivor bias.
This concern is valid. This is due to several reasons. First, the R² presented is relatively low as the model fits only 32%. This means that 68% of the data is not explained by the model. Another point is the height of alpha. The monthly Sand Hill Index shows an average alpha in % per year of 4.92 at the significance level of 1, 5 and 10% level. The quarterly CA Index shows an alpha of 6.1 in % per year. According to the book ‘Venture capital and the Finance of Innovation (Wiley, 2010), these are lower and upper bounds of abnormal gross returns. The CA Index is considered an upper bound as the method of data collection of the Index is already considered having survivor bias. If we consider the fact that 5,73 and 6,1 are lower and upper bounds in the period of 1989 – 2008 plus given the fact that the financial crisis hit in 2008, the height of alpha = 7,5 could be considered as a concern. Furthermore, Largeco calculates their returns on the VC portfolio by adding the cash-flows and the reported company values from their funds. In the 10 years that Largeco operated (2006 – 2016), companies