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  3. b. suppose the index model for stocks a and b is e

b. Suppose the index model for stocks A and B is estimated from excess returns...

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b. Suppose the index model for stocks A and B is estimated from excess returns with the following results: RA = 3% + 0.7Rm + en RB = -2% + 1.2RM + eb 20%; RSquaredA = 0.20; RSquaredp = 0.12 OM = i. What is the standard deviation of each stock? [4 marks] ii. Break down the variance of each stock into its systematic and idiosyncratic components. [4 marks] iii. Assuming the residuals of the index models are independent of each other, what are the covariance and the correlation coefficient between the two stocks? [4 marks] iv. What is the covariance between each stock and the market index? [4 marks] V. Consider portfolio P with investment propositions of 0.60 in A and 0.40 in B. What is the covariance between portfolio P and the market index? [6 marks] vi. Now, consider another portfolio Q with investment propositions of 0.50 in A, 0.30 in the market, and the remaining T-Bills. What is the covariance between portfolio Q and the market index? [8 marks]

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