Problem 3 (15 marks)

Suppose that the index model for two Canadian stocks HD and ML is estimated with the following results:

R_HD =0.03+0.95R_M+e_HD

R-squared =0.55

R_ML =-0.06+2.10R_M+e_ML

R-squared =0.46

_M =0.22

where M is S&P/TSX Comp Index and R_X is the excess return of stock X.

• What is the standard deviation of each stock? (Hint: b_i = (_{iM i}) / _M.)
• What is the systematic risk of each stock?
• What is the covariance and the correlation coefficient between HD and ML?
• For portfolio P with investment proportion of 0.4 in HD and 0.6 in ML, calculate the systematic risk, non-systematic risk, and total risk of P.