Suppose that there are two assets, A and B, and their returns are derived by the...

  

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Suppose that there are two assets, A and B, and their returns are derived by the two-factor model below: The first factor has an expected rate of return of 1-5% and a standard deviation 01-3%. The second factor has an expected rate of return of 12=12% and a standard deviation 02-5%. The returns between the two factors and the returns between the idiosyncratic component of each asset and each factor are uncorrelated. The risk-free rate of return is RF = 2%. The table below summarises the coefficients ai, bii, bi and the standard deviation of the error term & for each asset: Asset A Asset B R = a +bul + bil + &i ai 0.4% 1.4% b 0.3 0.2 bi 0.5 0.1 dei 22% 9% a. Estimate the expected returns and the standard deviation of returns for the two assets. [15 marks] b. Find the optimal risky portfolio and calculate its expected return and its standard deviation of returns. [15 marks] c. Mrs. H has an initial wealth Wo-10,000,000. Her state-specific utility as a function of her wealth is given by the equation below. Compute her overall optimal portfolio by investing her wealth in assets A, B and the risk-free asset. UH (W) = w 1 25,000,000 -w [30 marks] Suppose that there are two assets, A and B, and their returns are derived by the two-factor model below: The first factor has an expected rate of return of 1-5% and a standard deviation 01-3%. The second factor has an expected rate of return of 12=12% and a standard deviation 02-5%. The returns between the two factors and the returns between the idiosyncratic component of each asset and each factor are uncorrelated. The risk-free rate of return is RF = 2%. The table below summarises the coefficients ai, bii, bi and the standard deviation of the error term & for each asset: Asset A Asset B R = a +bul + bil + &i ai 0.4% 1.4% b 0.3 0.2 bi 0.5 0.1 dei 22% 9% a. Estimate the expected returns and the standard deviation of returns for the two assets. [15 marks] b. Find the optimal risky portfolio and calculate its expected return and its standard deviation of returns. [15 marks] c. Mrs. H has an initial wealth Wo-10,000,000. Her state-specific utility as a function of her wealth is given by the equation below. Compute her overall optimal portfolio by investing her wealth in assets A, B and the risk-free asset. UH (W) = w 1 25,000,000 -w [30 marks]

Answer rating: 100% (QA)

a To estimate the expected returns and standard deviation of returns for assets A and B well use the twofactor model Ri alphai b1il1 b2iI2 epsiloni For asset A Expected Return ERA alphaA b1AEl1 b2AEI2 ... View the full answer