1. Suppose Stock A has a return of 10% and standard deviation of 20% and Stock B has a return of 15% and standard deviation of 30%. The correlation between stock A and B is 1. Draw the efficient frontier for these two stocks. Is there an arbitrage opportunity? If so, what restriction would eliminate the arbitrage?
2. Evaluate the following claim: "Stocks tend to be less risky in the long-run. Even though stocks can go down substantially in a given year, historically, there has never been a 20 year time period in which stocks had negative returns. You can diversify your risk over time just like you can diversify your risk by holding many stocks in your portfolio. You can reduce the variation of your portfolio by a factor of 20 over a 20 year time period."
3. Comment on the following statement: "If I estimate a Fama/French three factor model for aspecific security and I find a statistically significant positive intercept, then I must have found an under-valued security."
4. R-squared from regressing Apple's stock return on amarket index is 0.8. The coefficient onthe market index (beta) is 2. Apple's variance is 0.2. What is the correlation between Apple and the market index? What percentage of Apple's variance is systematic?