Suppose that the index model for stocks A and B is estimated from excess returns with the following results:

_A = 3% + 0.7 R_M+ _A

_B = 2% + 1.2R_M + _A

_A-square= 0.20 ; _B-square= 0.12, variance_M = 20% ;

a. What is the standard deviation of each stock?

b. Break down the variance of each stock to the systematic and firm-specific components.

c. What are the covariance and correlation coefficient between the two stocks?

d. What is the covariance between each stock and the market index?

e. For portfolio P with investment proportions of 0.60 in A and 0.40 in B, rework parts (a), (b) and (d). f. Rework part (e) for portfolio Q with investment proportions of 0.50 in P, 0.30 in the market index, and 0.20 in T-bills.