7. Jim believes CAPM (he uses CAPM to calculate fair expected return). On February 10, Jim forms the following one-month return expectations. stock A stock B E(ra) Covli, M) 6 % 1.6 14% 3.6 The one-month market portfolio's variance is 2.4. The one month risk-free rate of return is 2%, and the one-month market portfolio's expected rate of return is 10%. (a) Jim is considering a portfolio P = 3 A+ 1o B. What is Portfolio P's alpha? Will Jim hold the portfolio P on Feb 10? Why? [4 points] Today (March 10), Jim reads Fund D's report, and surprisingly finds that Fund D holds the portfolio P on Feb 10. Fund D's realized rate of return is 10%. Fund D reports that the fund employs a two-factor model ri = E(ri) + BiiFi + B2iF2 + ti, (0.1) and its analysis shows that in the portfolio P, A's idiosyncratic component just offsets mponent. Factor 1 is actually the surprise of the market portfolio rate of return. For the two-factor model, data show B1a = 2/3, B2A = 0.8, B1B = 3/2, and B2B = -1.2. Factor l's realized value is 0%, and Factor 2's realized value is 0.1. (b) What is the alpha Fund D generates from Feb 10 to March 10 according to the two-factor model? [4 points) (c) After reading the report and studying lecture notes of HKBU's Investment class, Jim now thinks that the two-factor model is a better pricing model. Suppose Fund Ds alpha represents Fund D's manager's stock-picking ability, and such an ability is constant over time. Will Jim invest in Fund D? Why? (2 points) 7. Jim believes CAPM (he uses CAPM to calculate fair expected return). On February 10, Jim forms the following one-month return expectations. stock A stock B E(ra) Covli, M) 6 % 1.6 14% 3.6 The one-month market portfolio's variance is 2.4. The one month risk-free rate of return is 2%, and the one-month market portfolio's expected rate of return is 10%. (a) Jim is considering a portfolio P = 3 A+ 1o B. What is Portfolio P's alpha? Will Jim hold the portfolio P on Feb 10? Why? [4 points] Today (March 10), Jim reads Fund D's report, and surprisingly finds that Fund D holds the portfolio P on Feb 10. Fund D's realized rate of return is 10%. Fund D reports that the fund employs a two-factor model ri = E(ri) + BiiFi + B2iF2 + ti, (0.1) and its analysis shows that in the portfolio P, A's idiosyncratic component just offsets mponent. Factor 1 is actually the surprise of the market portfolio rate of return. For the two-factor model, data show B1a = 2/3, B2A = 0.8, B1B = 3/2, and B2B = -1.2. Factor l's realized value is 0%, and Factor 2's realized value is 0.1. (b) What is the alpha Fund D generates from Feb 10 to March 10 according to the two-factor model? [4 points) (c) After reading the report and studying lecture notes of HKBU's Investment class, Jim now thinks that the two-factor model is a better pricing model. Suppose Fund Ds alpha represents Fund D's manager's stock-picking ability, and such an ability is constant over time. Will Jim invest in Fund D? Why? (2 points)