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7. Suppose that the assumptions of the single-index model hold and that the model for stocks D and E is estimated from excess returns with

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7. Suppose that the assumptions of the single-index model hold and that the model for stocks D and E is estimated from excess returns with the following results: RD=3%+1.25RM+eDRE=1.4%+2RM+eEM=20% The residual standard deviations for the 2 assets are: (eD)=15% and (eE)=18% i) Compute the R-squared coefficients of the 2 regressions above. For which stock does market movement explain a greater fraction of return variability? (4 marks) ii) What are the covariance and the correlation coefficients between the 2 stocks? (5 marks) iii) Which one of the 2 stocks would be overpriced according to CAPM? (5 marks) iv) If a portfolio P is created using 40% in stock D, 50\% in stock E and 10% in a T-bill, what would be the beta of portfolio P ? (4 marks) v) If we try to estimate the index model by running a regression of RP on RM what would the R-squared coefficient be? 7. Suppose that the assumptions of the single-index model hold and that the model for stocks D and E is estimated from excess returns with the following results: RD=3%+1.25RM+eDRE=1.4%+2RM+eEM=20% The residual standard deviations for the 2 assets are: (eD)=15% and (eE)=18% i) Compute the R-squared coefficients of the 2 regressions above. For which stock does market movement explain a greater fraction of return variability? (4 marks) ii) What are the covariance and the correlation coefficients between the 2 stocks? (5 marks) iii) Which one of the 2 stocks would be overpriced according to CAPM? (5 marks) iv) If a portfolio P is created using 40% in stock D, 50\% in stock E and 10% in a T-bill, what would be the beta of portfolio P ? (4 marks) v) If we try to estimate the index model by running a regression of RP on RM what would the R-squared coefficient be

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