1:Suppose that the excess return for all securities can be described by a single index model: R_i = _i + _iR_m + e_i

The standard deviation of the market portfolio is 18%. Data for securities A, B and C are presented in the table below:

Security	i	E(Ri)	(ei)
A	0.4	11%	27%
B	1.2	13%	15%
C	1.3	13%	10%

Suppose that an investor forms a well-diversified portfolio of type A securities. What would be the variance of the portfolio's excess return, assuming there is an infinite number of securities with return characteristics which are identical to the characteristics of security A?

2:

Assume that the single index model is valid. You've collected the following information about excess returns for two stocks, A and B, their residual standard deviations, and the standard deviation of the macroeconomic factor, M:

• R_A = -0.1 + 0.8 R_M + e_A
• R_B = 0.2 + 1.5 R_M + e_B
• (e_A) = 0.4
• (e_B) = 0.2
• _M = 0.26

Attempt 1/10 for 10 pts.

Part 1

What is the standard deviation of stock A?

Part 2

What is the standard deviation of stock B?

Submit

What is the covariance between the returns on stocks A and B?