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Finance and Accounting

Finance and Accounting
Bibliography & Referencing:
You are expected to consult academic journal articles and professional journal articles, where appropriate. Please remember to reference your sources
using an appropriate citation system (such as Harvard style). Essays will lose marks for poor referencing. Guidance for referencing styles can be
found in the library and online:
Please ensure you attach a cover sheet to your assignment. The cover sheet should contain the following information: your student number, module
code, module title, date submitted, and word count. The template of the cover sheet will be uploaded to Learning Central.
There are two parts to the assignment, which test your understanding of quantitative research methods. The first part is a test of the Capital Asset
Pricing Model (CAPM) and Fama-French three-factor asset pricing models using returns of a portfolio including stocks from a particular industry. The
second part is an examination of firm characteristics that may affect audit fees, using a unique sample of UK firms.
The data for the assignment can be found at S:/Teaching/Research Methods. Your unique data allocation can be found in the file S:/Teaching/Research
Methods/Coursework 2 – Data Allocation 14-15.xls. The data allocation spreadsheet shows you precisely which data you should use for your assignment.
For Part 1, you are allocated a specific industry stock portfolio to investigate. The time series data (monthly) of industry portfolio returns are
found in the spreadsheet S:/Teaching/Research Methods/Coursework 2 – Industry Portfolios 14-15.xls. For part 2, you are allocated a random cross-
sectional data sample of 5,000 firms. Your specific data set for investigating audit fees in part 2 can be found at S:/Teaching/Research
The spreadsheet S:/Teaching/Research Methods/ Coursework 2 – Pricing Factors 14-15.xls contains the monthly market (mkt-rf), size (smb), book-to-
market (hml) and momentum (umd) asset pricing factors for US stocks from January 1963 (1963m1) to July 2013 (2013m7). It also contains the monthly
returns of six portfolios sorted by size and book-to-market ratios (B/M) for any additional analysis if possible.
Use these asset pricing factors to test the validity of the Capital Asset Pricing Model (CAPM) for your industry portfolio returns. Compare your
results to those for the six portfolios sorted by size and B/M. Write a detailed commentary to explain the regression models, hypothesis testing,
diagnostic tests and analysis of residuals that you are using and interpret your findings. Your commentary should include the following:
(a) An explanation of the theories and models being tested,
(b) A statement of coefficient values under the null hypotheses,
(c) Presentation of regression analysis,
(d) Interpretation of hypothesis testing on coefficients,
(e) Analysis of diagnostic tests to evaluate the goodness of fit of your regression model,
(f) Analysis of residuals to explain the possible bias, demonstrate how these potential bias may be corrected, and discuss any differences in results
after adjusting for the bias.
(g) Any other data, tests, or information that you feel are interesting and relevant.
Essential reading:
A very good literature review on the CAPM (this assignment is related to the time series regression test of CAPM):
(1) Fama, E. F., and French, K. R., (2004). The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives 18, 25-46.
Two seminal papers of the Fama and French three-factor model:
(2) Fama, E. F. and French, K. R. (1992). The cross-section of expected stock returns. Journal of Finance 47, 427-465.
(3) Fama, E. F. and French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33, 3-56.
Your spreadsheet (AUDITx.csv) contains a random sample of a cross section of 5,000 UK firms. I suggest that you first save your file as a new Excel
workfile. For each firm, you have been provided with the following variables:
(i) log of audit fee (logafee);
(ii) log of sales (logsal);
(iii)log of total assets (logta);
(iv) number of subsidiaries (nsubs);
(v) exports divided by sales (expsales);
(vi) total liabilities divided by total assets (gearing) (tlta);
(vii) return on total assets (retta);
(viii) current assets divided by current liabilities (cacl);
(ix) a dummy variable to indicate if the firms audit is performed by one of the big four auditors (big4).
Use the data on the variables listed above to investigate whether firm characteristics explain the cost of audit. Write a detailed commentary to
explain the regression models, hypothesis testing, diagnostic tests and analysis of residuals that you are using and interpret your findings. Your
commentary should include the following:
(a) An explanation of how and why these variables could explain audit fees,
(b) A statement of coefficient values under null hypotheses,
(c) Presentation of regression analysis
(d) Interpretation of hypothesis testing on coefficients,
(e) Analysis of diagnostic tests to verify the validity of your regression model,
(f) Analysis of residuals,
(g) Any other information or tests that you feel are relevant.
Essential reading:
(1) Clatworthy, M. A. and Peel, M. J. (2007). The effect of corporate status on external audit fees: Evidence from the UK. Journal of Business
Finance and Accounting, 34, 169-201.
(2) Chan, P., Ezzamel, M. and Gwilliam, D., (1993). Determinants of Audit Fees for Quoted UK Companies. Journal of Business Finance & Accounting,
Vol. 20, No. 6, pp. 765-786.

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