Question

# Suppose that the index model for stocks A and B is estimated from excess returns with...

Suppose that the index model for stocks A and B is estimated from excess returns with the following results:

RA = 4.5% + 1.40RM + eA

RB = –2.2% + 1.7RM + eB

σM = 24%; R-squareA = 0.30; R-squareB = 0.20

Break down the variance of each stock to the systematic and firm-specific components. (Do not round intermediate calculations. Calculate using numbers in decimal form, not percentages. Round your answers to 4 decimal places.)

 Risk A Risk B Systematic Firm-specific

Variance of A=Beta A^2*Standard Deviation of M^2/Ra^2 =1.4^2*24%^2/0.30 =0.37362
Variance of of B=Beta B^2*Standard Deviation of M^2/Rb^2 =1.7^2*24%^2/0.20 =0.83232

Systematic Risk of A=Beta A^2*Standard Deviation of M^2=1.40^2*24%^2=0.1129
Firm Specific risk of A =Variance of Risk A-Systematic Risk=0.37362-0.1129 =0.2634

Systematic Risk of B=Beta A^2*Standard Deviation of M^2=1.7^2*24%^2=0.1665
Firm Specific risk of B=Variance of Risk B-Systematic Risk=0.83232-0.1665 =0.6658