Question3 Answer all parts of this question (a) Consider three risky assets A, B and C with variances 146, 854 and 289 respectively and covariances between cov(A,B) 187, cov(A,C)145 and cov(B,C) 104. The investment in each asset is 120, 190 and 690, respectively. The expected return on the market is 22.4% with standard deviation 15.2% and the risk-free rate is 4%. Assuming that these asets comprise the market portfolio calculate the expected equilibrium return for these assets as well as their levels of market and idiosyncratic risk. [50 marks] Describe the process of how undervalued securities, with positive alphas, will come to equilibrium (b) 20 marks] (c) Explain why the correlation between two assets as computed using the CAPM might differ from the actual historical correlation. Give the formula for the CAPM implied correlation and historical correlation and discuss. [30 marks] Total 100 marks] Question3 Answer all parts of this question (a) Consider three risky assets A, B and C with variances 146, 854 and 289 respectively and covariances between cov(A,B) 187, cov(A,C)145 and cov(B,C) 104. The investment in each asset is 120, 190 and 690, respectively. The expected return on the market is 22.4% with standard deviation 15.2% and the risk-free rate is 4%. Assuming that these asets comprise the market portfolio calculate the expected equilibrium return for these assets as well as their levels of market and idiosyncratic risk. [50 marks] Describe the process of how undervalued securities, with positive alphas, will come to equilibrium (b) 20 marks] (c) Explain why the correlation between two assets as computed using the CAPM might differ from the actual historical correlation. Give the formula for the CAPM implied correlation and historical correlation and discuss. [30 marks] Total 100 marks]