Question 2: Applications (60 points) Suppose that you have just started your first job as a junior investment analyst at a hedge fund. You have the data on average annual returns (that is, yield) and risk levels for the following five securities that your fund is holding (e.g. corporate bonds): Security # Return (in %) Risk 2.5753 4.3934 14.2423 10.2303 3.3583 Table 1: Risk-return characteristics of five portfolio securities. The risk index is a number between 0 and 100 that is increasing with security's market risk (e.g. risk index of 0 represents a risk-free security such as a government bond). Suppose that you wish to use these data to estimate the following regression model: Y = B1 + B2X2 + wi, (1) for i = 1, ...,5, where y, is return (in percent)and X2 is the risk index for security i. (a) (10 points) Use vector OLS to obtain estimate of the coefficients vector . Show your work. You may use the fact that here, (X'X)-- = 0.47836 (4 -0.01618] ) -0.01618 0.00094 (b) (5 points) Using your estimate , what is the expected annual return to a risk-free security? (c) (5 points) Using your estimate 8, what is the expected annual return to a bond with a risk index of X2 = 50