Question

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

RA = 3% + 0.7RM+eA RB = -2%+1.2RM+eB R2A= 0.2 R2B = 0.12σM = 20%

For portfolio P with investment proportions of 0.60 in A and 0.40 in B,

a. What is the standard deviation of each stock?

b. Break down the variance of each stock to the systematic and firm-specific components.

c. What is the covariance between each stock and the market index?

For portfolio Q with investment proportions of 0.50 in P, 0.30 in the market index, and 0.20 in T-bills.

d. What is the standard deviation of each stock?

e. Break down the variance of each stock to the systematic and firm-specific components.

f. What is the covariance between each stock and the market index?

Answer 1