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Assume a market index represents the common factor, and all stocks in the economy have a beta of 1.0. All stocks have independent firm-specific (annual
Assume a market index represents the common factor, and all stocks in the economy have a beta of 1.0. All stocks have independent firm-specific (annual return) components with a standard deviation of 20%. Suppose an analyst studies 20 stocks and finds that one-half have an alpha of 5% annually and one-half have an alpha of 5% annually. The analyst then buys $100,000 of an equally weighted portfolio of the positive alpha stocks and sells short $100,000 of an equally weighted portfolio of the negative alpha stocks. a) What are the analyst's expected annual profit (in dollars) and its standard deviation? Explain the risk involved in the analyst's strategy both quantitatively and qualitatively (i.e., explain in your own word). b) How does the answer in part a) change if the number of stocks is 50 instead of 20 ? What if the number of stocks is 100 instead of 20
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