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3. Suppose the index model for stocks A and B is estimated from the excess returns with the following results: rA=2%+0.7RM+eA,rB=2%+1.5RM+eB,M=20%, and the regression R2

3. Suppose the index model for stocks A and B is estimated from the excess returns with the following results: rA=2%+0.7RM+eA,rB=2%+1.5RM+eB,M=20%, and the regression R2 of stocks A and B is 0.30 and 0.25, respectively. Answer the following questions. Total: 20 marks. (a) What is the variance of each stock? (5 marks) (b) What is the firm-specific risk of each stock? (5 marks) (c) What is the covariance between the two stocks? (5 marks) 1 (d) What is the covariance between each stock and the market index

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