1. Assume that stock market returns have the market index as a common factor, and that all stocks in the economy have a beta of 1.4 on the market index. Firm-specific returns all have a standard deviation of 40%. Suppose that an analyst studies 20 stocks and finds that one-half of them have an alpha of +2.0%, and the other half have an alpha of 2.0%. Suppose the analyst invests $1.0 million in an equally weighted portfolio of the positive alpha stocks, and shorts $1 million of an equally weighted portfolio of the negative alpha stocks. a. What is the expected profit (in dollars) and standard deviation of the analysts profit? (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

b. How does your answer change if the analyst examines 60 stocks instead of 20 stocks? 120 stocks? (Do not round intermediate calculations. Round your answers to the nearest whole dollar amount.)

2.

Suppose that there are two independent economic factors, F₁ and F₂. The risk-free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of 55%. Portfolios A and B are both well-diversified with the following properties:

Portfolio			Beta on F1			Beta on F2			Expected Return
	A			1.7			2.2			33	%
	B			2.7			0.22			30	%

What is the expected return-beta relationship in this economy? Calculate the risk-free rate, r_f, and the factor risk premiums, RP₁ and RP₂, to complete the equation below. (Do not round intermediate calculations. Round your answers to two decimal places.) E(r_P) = r_f + (_P1 RP₁) + (_P2 RP₂)