Suppose that a two-factor model, where the factors are the market return and the growth rate of industrial production, correctly describes the risk-return characteristics of all assets. Consider two well-diversified portfolios A, B, and C with the following characteristics. The risk-free rate is 5%. Portfolio Expected Return Sensitivity to Factor 1 Sensitivity to Factor 2 A 10% 1 -1 B 15% 0.5 1 ? 1 0.5 What is the APT-consistent expected rate of return on C? 12.5% O 17.5% O 2.5% O 7,5%

Suppose that a two-factor model, where the factors are the market return and the growth rate of industrial production, correctly describes the risk-return characteristics of all assets. Consider two well-diversified portfolios A, B, and C with the following characteristics. The risk-free rate is 5%. Portfolio Expected Return Sensitivity to Factor 1 Sensitivity to Factor 2 A 10% 1 -1 B 15% 0.5 1 ? 1 0.5 What is the APT-consistent expected rate of return on C? 12.5% O 17.5% O 2.5% O 7,5%

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (SDi), covariance (COVij), and asset weight (Wi) are as shown below? Asset (A) E(R₂) = 10% SDA = 8% WA = 0.25 COVAB = 0.006 Select one: A. 13.75% B. 7.72% C. 12.5% D. 8.79% Asset (B) E(RB) = 15% SDB = 9.5% WB = 0.75
Consider an economy with a (net) risk-free return r1 = 0:1 and a market portfolio with normally distributed return, with ErM = 0:2 and 2M = 0:02. Suppose investor A has CARA preferences, with risk aversion coe¢ cient equal to 1 and an endowment of 10. a) Write down the maximization problem for the investor. b) Determine the amount invested in the risky portfolio and in the risk-free asset. c) Suppose another investor (B) has a coe¢ cient of absolute risk aversion equal to 2 (and the same endowment 10). Compute his optimal portfolio and compare it to that of investor A. Explain the di§erent results for investors A and B. d) Finally, consider Investor C with mean-variance preferences Ec V ar(c) (and endowment 10). Compute his optimal portfolio and compare it to that of investors A and B (as obtained in questions b and c). Compare your result with those obtained for investors A and B.
4. Suppose that there are 2 assets with ri 012 = 0.005. = 0.20, 01 = = 0.40, 2 = 0.10, 02 = 0.25 and (a) If ro = 0.02, what are the market portfolio return and variance? What are the corre- sponding weights (i.e. how much to invest in asset 1, asset 2, and the risk-free asset to get the market portfolio)? Answer. (b) If ro 0.05, what are the market portfolio return and variance? What are the corre- sponding weights? Answer.
The optimal proportion of the risky asset in the complete portfolio is given by the equation below y*= E(Rp− Rf) A0² For each of the variables on the right side of the equation, discuss the impact of the variable's effect on y* and why the nature of the relationship makes sense intuitively. Assume the investor is risk averse
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What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (SDi), covariance (COVij), and asset weight (Wi) are as shown below? Asset (A) E(R₁) = 10% SDA = 8% WA = 0.25 COVAB = 0.006 Asset (B) E(R₂) = 15% SDB = 9.5% WB = 0.75
Suppose that a two-factor model, where the factors are the market return (Factor 1) and the growth rate of industrial production (Factor 2), correctly describes the return generating processes of all assets and the corresponding two-factor APT correctly prices three well- diversified portfolios, A, B, and C. Expected Return Portfolio A BC с 15% 20% 6% Sensitivity to Factor 1 1 1 0 Sensitivity to Factor 2 0 1 0 a. What are i) the risk premiums of the two factors and ii) the risk-free rate? b. Another well-diversified portfolio D has sensitivities 0 and 1 to factor 1 and factor 2, respectively. What is the APT-consistent expected return on Portfolio D? c. Suppose that Portfolio D's expected return is 10%. Given your answers above, form a portfolio consisting of Portfolios A, B, C, and D that generates an arbitrage profit. Express the other portfolio weights by using that of D as the numeraire- 1 or -1. Show your workings.
Suppose you observe the following situation:Security Beta Expected ReturnDiamond Co 1.3 0.2Spade Co 0.8 0.14 (a) According to the above information, could we figure out the market return and risk-free rate? Explain your answer. (b) Discuss the possibility of including zero beta or negative beta assets in your portfolio. Explain the pros and cons of including these types of assets.

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