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Problem 2

The document presents a problem set focused on financial concepts such as the expected return and standard deviation of market portfolios, CAPM, and the two-factor model. It includes specific calculations for efficient portfolios, expected returns of stocks, and portfolio shares involving risk-free assets. The problems require the application of financial theories and formulas to derive various metrics related to investment returns and risk.

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Illyes Nouari
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9 views2 pages

Problem 2

The document presents a problem set focused on financial concepts such as the expected return and standard deviation of market portfolios, CAPM, and the two-factor model. It includes specific calculations for efficient portfolios, expected returns of stocks, and portfolio shares involving risk-free assets. The problems require the application of financial theories and formulas to derive various metrics related to investment returns and risk.

Uploaded by

Illyes Nouari
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Problem Set 2

1. (a) Suppose that the expected return and standard deviation of the
market portfolio are r̄M = 0.08 and σM = 0.18, and the riskfree
rate is rf = 0.01.
i. Derive the expected return of an efficient portfolio with stan-
dard deviation of 0.20
ii. A stock has covariance with the market portfolio σiM = 0.03
and standard deviation of 0.25. Derive its expected return
under CAPM.
iii. Derive the idiosyncratic variance of the stock’s return.

2. Suppose that the expected return and standard deviation of the market
portfolio are r̄M = 0.05 and σM = 0.1, and the riskfree rate is rf =
0.01. A stock has correlation with the market portfolio of 0.5 and
standard deviation of 0.16.

(a) Derive its expected return under CAPM.


(b) What is the standard deviation of an efficient portfolio with the
same return?
(c) What portfolio shares of the risk free asset and market portfolio
do you need to hold to get this return?

3. Two stocks are believed to satisfy the two factor model

r1 =a1 + 2f1 + f2
r2 =a2 + f1 + 3f2

There is a risk-free asset with a return of 2% and we know that r̄1 =


6%, r̄2 = 9%.

(a) What are the values of λ1 , λ2 for this economy?

1
(b) Suppose an asset has one unit of exposure to factor 1 and none
to factor 2. What is its expected return?

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