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Question 2 ( Applications ) 2 0 points Suppose that you have just started your first job as a junior investment manager at a hedge

Question 2(Applications)20 points
Suppose that you have just started your first job as a junior investment manager at a
hedge fund. You have the data on the risk levels and the corresponding expected return
(appreciation, or yield) of the following five securities (e.g. stocks, or bonds):
Table 1: Risk-Return Characteristics of Five Securities
(a)(12 points) Use the OLS formulas provided in class, or from the textbook, to regress
the expected return of a security (Yi) on the corresponding risk index (xi). That is,
estimate the following regression model:
Yi=0+1xi+ui
Report your estimates hat()0 and hat()1. Show your work.
(b)(4 points) Use your estimates hat()0 and hat()1 to find the expected return to a risk-free security,
that is, a security with risk index xi=0. In other words, find hat(E)[Y|xi=0].
(c)(4 points) Suppose a broker offers you to invest in a security with expected return of
14% and a risk index of 20. Based on your regression estimates and the model in (1),
does that represent a good deal? Explain your reasoning.
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