Question
Consider a market where the stock returns are generated by a two-factor model. Sensitivity (beta) of Stock A to Factor 1 is 1.5 and its
Consider a market where the stock returns are generated by a two-factor model. Sensitivity (beta) of Stock A to Factor 1 is 1.5 and its sensitivity to Factor 2 is 0.6. Sensitivity of Stock B to Factor 1 is 0.5 and its sensitivity to Factor 2 is 1.6. The standard deviation of Factor 1 returns is 20%, the standard deviation of Factor 2 returns is 25%. The correlation between the two factors is 0.5. The idiosyncratic risk of Stock A (standard deviation of idiosyncratic return) is 15% and the idiosyncratic risk of Stock B is 10%. What is the covariance between Stock A and Stock B returns?
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