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QUESTION 1 ANSWER ALL PARTS OF THE QUESTION a. Explain how the CAPM beta of...

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Finance

QUESTION 1 ANSWER ALL PARTS OF THE QUESTION a. Explain how the CAPM beta of a stock is estimated. [3 marks] b. Suppose the index model for stocks A and B is estimated from excess returns with the following results: = 3% + 0.7 + = 2% + 1.2 + = 20%; = 0.20; = 0.12 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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