Question
Please show calculation in excel. Suppose that asset returns are described by a 2-factor APT model, which applies exactly to all assets: ~ri = ri
Please show calculation in excel.
Suppose that asset returns are described by a 2-factor APT model, which applies exactly to all assets: ~ri = ri + bi1 ~ f1 + bi2 ~ f2 + ~ui; i = 1; 2; : : : where both factors have unit variance and are uncorrelated with each other. The risk premia associated with factors 1 and 2 are 20% and 30%, respectively. The risk-free rate is 2%. (a) We are contemplating investing in a stock, which has the following factor loadings: b1 = 0:20 and b2 = 0:10. According to APT, what should be the expected return on this stock? (b) Consider two stocks, 1 and 2, with the following parameters. For stock 1: b11 = 0:2, b12 = 0:1, SD(~u1) = 0:20. For stock 2: b21 = 0:1, b12 = 0:4, SD(~u2) = 0:25. Compute the correlation between returns on stocks 1 and 2. (c) Construct a portfolio with stocks 1 and 2 above, with weights w1 and w2, with the expected return equal to the risk-free rate. What is w1?
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