Question of the Week: Level 1 – Quantitative Methods

Question

A company you follow, Water Magic Inc., has had a new CEO for 25 months now.  While profitability is up, you notice that the volatility, as measured by the variance, of the stock’s monthly returns has also increased significantly, measured at 6.63%.  The previous CEO of water Magic has moved over to another publicly traded company in the same industry, Earth Magic Inc.  You measure the volatility in stock price returns over 21 months for Earth Magic and find it to be 4.85%, in line with what the volatility of returns were when he ran Water Magic.  You wish to test if stock price volatility of Water Magic is higher than that of Earth Magic.

With reference to the F-table, what is the critical value at the 5% level of significance?

 	A. 2.00
 	B. 2.03
 	C. 2.08

MarkMeldrum · Answer

The correct answer is Option C. The larger variance is in the numerator.6.63% is associated with 25 observations giving it 24 degrees of freedom.4.85% is associated with 21 observations giving it 20 degrees of freedom.Looking across the top for df = 24 and down the first column for df = 20, and, we find 2.08.

pinkmonkey · Answer

I do not understand whatever% is associated with whatever observations is going to give whatever degree of freedom.Could you give me a simple explanation for this, please?