+ 3. For the next three questions, consider a market neutral hedge funds invested in the "Betting Against Beta" strategy. The strategy involves going long low beta stocks and short high beta stocks due to a view that investors have excess demand for high beta assets due to leverage constraints. In this particular strategy, the following assets can be traded < Asset class Risk free Expected annual return E(r+) < 2%7 Market B 0 < Portfolio of low stocks < 6% 0.5 Market portfolio 7% < 1.0 Portfolio of high stocks < 8% < 1.5 1) Let Wrf, Wlow, Wmarket, and Whigh denote the portfolio weights of the investment in each of the asset classes such that Wrf + Wlow + Wmarket + Whigh = 1. According to its investment mandate, hedge fund AAA should target a gross leverage of 2. Which portfolio will this hedge fund hold? < a. Wrf = -1, Wlow = 1.5, Wmarket = 0, Whigh = -0.5 b. Wrf = 1, Wlow = 3, wmarket = 0, Whigh = 1 < C. Wrf = 0, Wlow 1.5, Wmarket = 0, Whigh = -0.5 d. Wrf = 1, Wlow = 1, Wmarket = 0, Whigh 1 e. Wrf = 0, Wlow = 1, Wmarket = 1, Whigh = 14 f. Wrf = -1, Wlow == -1, Wmarket = 0, Whigh = 3 < 2 The hedge funds estimate the following excess returns (i.e., in excess of the risk-free rate) of the low- and high- portfolios on the excess return on the market (i.e., in excess of the risk-free rate): < W low B = t low B + 0.5 market +&t low B high high B = market +1.5 r high B + t where all r's are excess returns, and the error terms &t low B and & high are independent over time and of each other, have zero means E(&t = low ) = E ( high ) : = var(& low = 0, and annual volatilities of var(& B) = high B) = 4%. The expected returns of stock portfolios and the risk-free asset are given above. 2) What is a. low B? -1.5% b. -1.0% C. 0.0% d. 1.0% e. 1.5% f. 2.0% g. 2.5% < 3) Hedge fund BBB targets a volatility of 10% (no target on gross leverage). What is the expected excess return (i.e., above the risk-free return) and Sharpe ratio of BBB hedge fund? (Write in the Sharpe ratio next to your circling the expected excess return.) < a. 2.37% b. 3.24% < C. 3.75% d. 4.24% < e. 4.74% < f. 7.50%