(a.) Estimating a single index model with four observations has revealed the following results: Rit =...

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(a.) Estimating a single index model with four observations has revealed the following results: Rit = 2.473 + 1.011 Rmt + Eit The four market returns used in the estimation were: 9%, 5%, -1% and -3% and the four residuals are 0.4286, 0.4725, -4.4615 and 3.5604. Calculate the total amount of risk, the common factor risk and the firm specific risk of asset-i. [40 marks] (b.) Suppose you have two risky assets and asset 2 is 30% more risky than asset 1. Assume that asset 1 has a beta of 1 and the expected returns of the two assets are 5% (asset 1) and 8% (asset 2). (i.) if the risk-free rate is 1% and asset 1 is correctly priced according to the CAPM, explain what you would do. (ii.) if asset 1 and asset 2 are correctly priced according to the CAPM, what would the risk-free rate be? [30 marks] (c.) Carefully explain why the CAPM proposes only common factor risk should be priced. [30 marks] (a.) Estimating a single index model with four observations has revealed the following results: Rit = 2.473 + 1.011 Rmt + Eit The four market returns used in the estimation were: 9%, 5%, -1% and -3% and the four residuals are 0.4286, 0.4725, -4.4615 and 3.5604. Calculate the total amount of risk, the common factor risk and the firm specific risk of asset-i. [40 marks] (b.) Suppose you have two risky assets and asset 2 is 30% more risky than asset 1. Assume that asset 1 has a beta of 1 and the expected returns of the two assets are 5% (asset 1) and 8% (asset 2). (i.) if the risk-free rate is 1% and asset 1 is correctly priced according to the CAPM, explain what you would do. (ii.) if asset 1 and asset 2 are correctly priced according to the CAPM, what would the risk-free rate be? [30 marks] (c.) Carefully explain why the CAPM proposes only common factor risk should be priced. [30 marks]

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Lets address each part of your question a Calculate the total amount of risk the common factor risk and the firmspecific risk of asseti The given singleindex model for asseti is Rit 2473 1011Rmt Eit W... View the full answer