Short Question (SQ2) The market index model can be formulated as: R = a +BR +...

 

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Short Question (SQ2) The market index model can be formulated as: R = a +BR + €. where R denote the annual excess returns of the risky asset and .R is the excess annual return on the market index, S&P 500. There are two risky funds, A and B, and their returns follow the above market index model. The estimations of annual means, annual standard deviations, and the parameters of the index model for Funds A and B and the S&P 500 index are in the table below. Assets Fund A Fund B S&P 500 (M) Risk premium 13% 7% 10% Standard deviation of returns 40% 20% 20% (15%) Market beta (B) 1.0 0.5 1.0 An investor wants to invest $10 thousands into funds A and B, and he plans to allocate 70% of his capital into A and the remaining into B. (A) What would be the alpha, beta, and R-squared for his portfolio (the combination of Funds A and B) under the market index model? (6%) (B) If this investor would like to short sell a hedging portfolio, constructed with S&P 500 index portfolio and the risk-free asset, to make his overall position market neutral, what is the dollar amount of the hedging portfolio should they short sell? (3%) (C) Please calculate the variance and Sharpe ratio of the overall position constructed in part (B). (6%) * Terminology: • A hedging portfolio here describes a position to be shorted to make the overall portfolio market neutral • Overall position describes the overall position combining the buy position and the short-sell position • Market-neutral in the market index model indicates having zero beta on the market index Short Question (SQ2) The market index model can be formulated as: R = a +BR + €. where R denote the annual excess returns of the risky asset and .R is the excess annual return on the market index, S&P 500. There are two risky funds, A and B, and their returns follow the above market index model. The estimations of annual means, annual standard deviations, and the parameters of the index model for Funds A and B and the S&P 500 index are in the table below. Assets Fund A Fund B S&P 500 (M) Risk premium 13% 7% 10% Standard deviation of returns 40% 20% 20% (15%) Market beta (B) 1.0 0.5 1.0 An investor wants to invest $10 thousands into funds A and B, and he plans to allocate 70% of his capital into A and the remaining into B. (A) What would be the alpha, beta, and R-squared for his portfolio (the combination of Funds A and B) under the market index model? (6%) (B) If this investor would like to short sell a hedging portfolio, constructed with S&P 500 index portfolio and the risk-free asset, to make his overall position market neutral, what is the dollar amount of the hedging portfolio should they short sell? (3%) (C) Please calculate the variance and Sharpe ratio of the overall position constructed in part (B). (6%) * Terminology: • A hedging portfolio here describes a position to be shorted to make the overall portfolio market neutral • Overall position describes the overall position combining the buy position and the short-sell position • Market-neutral in the market index model indicates having zero beta on the market index

Answer rating: 100% (QA)

A Alpha Beta and RSquared for Portfolio combination of Funds A and B Alpha Alpha is the difference between the expected return of the portfolio and th... View the full answer