Question: Assume that security returns are generated by the single-index model, R i = i + i R M + e i where R i is

Assume that security returns are generated by the single-index model,

R_i = _i + _iR_M + e_i

where R_i is the excess return for security i and R_M is the markets excess return. The risk-free rate is 2%. Suppose also that there are three securities A, B, and C, characterized by the following data:

Security	_i	E(r_i)	(e_i)
A	1.2	12%	25%
B	1.3	13	11
C	1.4	14	20

a. If _M = 23%, calculate the variance of returns of securities A, B, and C. (Do not round intermediate calculations. Round your answers to the nearest whole number.)

	Variance
Security A
Security B
Security C

b. Now assume that there are an infinite number of assets with return characteristics identical to those of A, B, and C, respectively. If one forms a well-diversified portfolio of type A securities, what will be the mean and variance of the portfolios excess returns? What about portfolios composed only of type B or C stocks? (Enter the variance answers as a percent squared and mean as a percentage. Do not round intermediate calculations. Round your answers to the nearest whole number.)

	Mean	Variance
Security A	%
Security B	%
Security C	%

c. Is there an arbitrage opportunity in this market?

multiple choice

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