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The Black-Scholes-Merton model assumes…

that both the risk-free rate and the volatility are known and constant.

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Financial Asset Classification and Measurement Model IFRS 9

financialAssetClassificationAndMeasurementModel

The lower the p-value reported for a test…

…the more significant the result.

Problems in Linear Regression and Their Solutions

Problem Effect Solution
Heteroskedasticity Incorrect standard errors Use robust standard errors (corrected for conditional heteroskedasticity)
Serial Correlation Incorrect standard errors (additional problems if a lagged value of the dependent variable is used as an independent variable) Use robust standard errors (corrected for serial correlation)
Multicollinearity High R^2 and low t-statistic Remove one or more independent variables may help.

t-distribution formula

t = (sample mean – population mean) / s/√n

s = sample standard deviation

n = sample size

How to use the t-statistic

  1. Determine the level of significance which is 100% minus the confidence level.
  2. Determine if it is a one-tail or a two-tail test. Confidence Intervals are always two-tailed.
  3. Determine degrees of freedom which is usually one less than the sample size.
  4. Look up the critical t-value
  5. Standard Confidence Interval is: sample mean +/- t-critical * standard deviation

Confidence Interval Around the Mean requires the use of standard error instead of standard deviation, standard error is calculated as follows:

standard error = standard deviation / √n

Like CAPM the Arbitrage Pricing Model assumes unsystematic risk is not priced?

TRUE

It can be diversified away.

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