Question
It is November, 2017. The following variance-covariance matrix, for the market (S&P 500) and stocks T and U, is based on monthly data from November
It is November, 2017. The following variance-covariance matrix, for the market (S&P 500) and stocks T and U, is based on monthly data from November 2012 to October 2017. Assume T and U are included in the S&P 500. The betas for T and U are T = 0.727 and U = 0.75.
S&P 500 T U
S&P 500 .0256 .0186 .0192
T .0186 .1225 .0262
U .0192 .0262 .0900
Average monthly risk premiums from 2002 to 2007 were: S&P500 : 1.0%
- T :0.6%
- U :1.1%
Assume the CAPM is correct, and that the expected future market risk premium is 0.6% per month. The risk-free interest rate is 0.3% per month.
a. What were the alpha's for stocks T and U over the last 60 months?
b. What are the expected future rates of return for T and U?
c. What are the optimal portfolio weights for the S&P 500, T and U? Explain qualitatively.
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