Question
a) If a share has an annual volatility of 25%, and a correlation with the market of 0.3, and the market has an annual volatility
a) If a share has an annual volatility of 25%, and a correlation with the market of 0.3, and the market has an annual volatility of 15%, what is the beta of the share, and what is its idiosyncratic risk?
b) In Exercise 2a, if the risk-free rate is 4% and the market risk premium (difference between the market expected return and the risk-free rate) is 6%, what is the expected return on the share?
c) If two shares each have a beta of 1 and annual volatility of 30% while the market has an annual volatility of 20%, what is the correlation between each of the shares and the market? What is the covariance of returns of the two shares, and what is the correlation between the two shares, assuming that the idiosyncratic risk of the two shares is uncorrelated?
d) How many shares would you need to hold in a portfolio to have an annual volatility of no more than 22%, assuming that they are as in the previous question (volatility of 30%, beta of 1 and idiosyncratic risk uncorrelated across stocks)?
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