SECTION B - ANSWER ONE QUESTION FROM THIS SECTION Question 2 The following models were fitted to data from

50 firms: Model 1 Model 2 where y = rate of return on equity for the firm, x = market share, x = measure of
2 3

firm size, x = industrial growth rate, x = level of world trade in industrial products.
4 5

Numbers in parentheses are coefficient standard errors. The following results were obtained: (a) Use Model (1) to test the null hypothesis, that the industrial growth rate is statistically insignificant in explaining the rate of return on equity. You should use a 5% level of significance. STATE HYPOTHESES AND FORMULAE for Parts (a) (c). Test stat = 0.66 and Critical = 2.0086, therefore the do not reject the null hypothesis, suggesting that the industrial growth is insignificant in explaining the rate of return on equity. [2 marks] (b) Use Model (1) to test the null hypothesis that world trade in industrial products has no effect on the rate of return on equity. Test stat = 0.822 and Critical = 2.0086, therefore the do not reject the null hypothesis, suggesting that the world trade in industrial products has no effect in explaining the rate of return on equity. [2 marks] (c) Based on models 1 and 2, examine the joint hypothesis that the coefficients on x and x are both equal to zero. The 5% critical value for F(2,45)=3.23.
5 4

[8 marks] Test Stat = 3.75 and Critical = 3.23, therefore we reject the null hypothesis suggesting that both variables (industrial growth and world trade in industrial products) are significant in explaining the rate of return on equity.

(d) Explain the difference between the outcomes in (a) and (b) compared with (c). [8 marks]

With outcomes of (a) and (b) we did not rejected the null hypothesis that beta 4 and beta 5 are equal to 0, suggesting that they are insignificant when explaining the rate of return on equity; however outcome (c) suggests that when both of the variables are considered together, they have an effect on explaining the rate of return on equity. This means that the industrial growth and the world trade in industrial products are linked together and one variable cannot explain the rate of return on equity without using the other variable.

(e) Why do these results suggest collinearity between the industrial growth rate and world trade in industrial products? [10 marks] DEFINE COLINEARITY Individually they are not significant and together they are significant, that indicates that some level of collinearity occurs as one variable cannot explain the returns without the other present. Slide 135-137 [Total - 30 marks]