finance

Project Description:

1. the expected rate of return on the market portfolio is 8% and the risk–free rate of return is 2%. the standard deviation of the market portfolio is 23%. what is the representative investor’s average degree of risk aversion?


2. stock a has a beta of 1.15 and a standard deviation of return of 35%. stock b has a beta of 2.50 and a standard deviation of return of 48%. assume that you form a portfolio that is 60% invested in stock a and 40% invested in stock b. using the information in question 1, according to capm, what is the expected rate of return on your portfolio?


3. using the information in questions 1 and 2, what is your best estimate of the correlation between stocks a and b?


4. your forecasting model projects an expected return of 11% for stock a and an expected return of 19% for stock b. using the information in questions 1 and 2 and your forecasted expected returns, what is your best estimate of the alpha of your portfolio when using capm to determine a fair level of expected return?


5. a different analyst uses a two–factor apt model to evaluate expected returns and risk. the risk premiums on the factor 1 and factor 2 portfolios are 4% and 6%, respectively, while the risk–free rate of return remains at 2%. according to this apt analyst, your portfolio formed in question 2 has a beta on factor 1 of 1.8 and a beta on factor 2 of 2.4. according to apt, what is the expected return on your portfolio if no arbitrage opportunities exist?


6. now assume that your forecasting model of question 4 accurately projects the expected return of stocks a and b and therefore your portfolio, and that the apt model of question 5 describes the fair rate of return for your portfolio. do any arbitrage opportunities exist? if yes, would you invest long or short in your portfolio constructed in question 2?
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