Q#3: [10 POINTS] Index Model: Consider the two (excess return) index model regression results for A and B: !! = #%+ #. '!" R-square = .576 Residual standard deviation = 10.3% !# = −'%+ )....

This is not an essay assignment, this is a problem set with 5 questions from Investment course. This course uses textbook called "Investments - by Bodie, Kane, Marcus - published by McGrawHill"


Q#3: [10 POINTS] Index Model: Consider the two (excess return) index model regression results for A and B: !! = #%+ #. '!" R-square = .576 Residual standard deviation = 10.3% !# = −'%+ ). *!" R-square = .436 Residual standard deviation = 9.1% a. Which stock has more firm-specific risk? b. Which has greater market risk? c. For which stock does market movement explain a greater fraction of return variability? d. If rf were constant at 6% and the regression had been run using total rather than excess returns, what would have been the regression intercept for stock A? Q#4: [10 PONITS] Using the two assets in question 3 above, assuming that the coefficient of risk aversion (A) and the correlation of the two assets are 4 and 0.6, respectively, find the portfolio that maximizes the individual’s utility given below: + = ,(.$) − # '12$ % [Hint: first define 3(4&) and 5&' as a function of the two assets and substitute them in the utility function before you optimize it] Q#5: [5 POINTS] CAPM: Are the following true or false? Explain. a. Stocks with a beta of zero offer an expected rate of return of zero. b. The CAPM implies that investors require a higher return to hold highly volatile securities. c. You can construct a portfolio with beta of .75 by investing .75 of the investment budget in T-bills and the remainder in the market portfolio. Q#6: [10 POINTS] CAPM: Assume that the risk-free rate of interest is 4% and the expected rate of return on the market is 14%. a. A share of stock sells for $50 today. It will pay a dividend of $6 per share at the end of the year. Its beta is 1.2. What do investors expect the stock to sell for at the end of the year? b. You are buying a firm with an expected perpetual cash flow of $1,000 but you are unsure of its risk. If you think the beta of the firm is .5, when in fact the beta is really 1, how much more will you offer for the firm than it is truly worth? c. A stock has an expected rate of return of 4%. What is its beta? Q#7: [10 POINTS] CAPM: Two investment advisers are comparing performance. One averaged a 19% rate of return and the other a 16% rate of return. However, the beta of the first investor was 1.5, whereas that of the second was 1. [Hint: Find the alphas (abnormal returns) of these two investors] a. Can you tell which investor was a better selector of individual stocks? b. If the T-bill rate were 6% and the market return during the period were 14%, which investor would be the superior stock selector? c. What if the T-bill rate were 3% and the market return were 15%? Q#8: [10 POINTS] APT: Suppose that there are two independent economic factors, F1 and F2. The risk- free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of 45%. The following are well-diversified portfolios: E스