Problem 3 (15 marks)

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

R_HD .02+0.80R_M+e_HD

R-squared .6

R_ML =-0.03+1.50R_M+e_ML

R-squared .4

_M .20

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

• What is the standard deviation of each stock?

• What is the systematic risk of each stock? What are the covariance and correlation coefficient between HD and ML?
• For portfolio P with investment proportion of 0.3 in HD and 0.7 in ML, calculate the systematic risk, non-systematic risk and total risk of P.