Question

Question 2

			Correlation Matrix
Securities	Expected Return E(Ri)	Standard Deviation σi	Google	Microsoft	Apple	Market Portfolio
Google	19.2%	36%	1.0	0.7	0.6	0.5
Microsoft	21.9%	35%		1.0	0.5	0.6
Apple	12.0%	25%			1.0	0.4
Market Portfolio	12.0%	10%				1.0

The risk-free interest rate is 3%.

1. Given the correlation matrix, what is the covariance between Google and the Market?

2. Given the correlation matrix, what is the beta of Microsoft?

3. Show that Microsoft is priced according to the CAPM.

4. What is the expected return and volatility of a portfolio that consists of a long position of $10,000 in Microsoft and a short position of $2,000 in Apple?        

Answer 1

1.
=Correlation of stock with market*standard deviation of stock*standard deviation of market
=0.5*36%*10%=0.018

2.
=Correlation of stock with market*standard deviation of stock/standard deviation of market
=0.6*35%/10%=2.10

3.
required return=risk free rate+beta*(market return-risk free rate)=3%+2.10*(12%-3%)=21.9000%

As expected return is same as required return, Microsoft is correctly priced

4.
=sqrt((10000/8000*35%)^2+(-2000/8000*25%)^2+(10000/8000)*(-2000/8000)*35%*25%*0.5)
=42.6193%