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There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 12
There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 12 percent. There are many securities in each market; thus, you can invest in as many stocks as you wish. Due to restrictions, however, you can invest in only one of the two markets. The expected return on every security in both markets is 12 percent. The returns for each security, i, in the first market are generated by the relationship: R1/ 12+1.5F+11 where 1/ is the term that measures the surprises in the returns of Stock / in Market 1. These surprises are normally distributed; their mean is zero. The returns on Security jin the second market are generated by the relationship: R2j = .12 +.5F+2j where 2j is the term that measures the surprises in the returns of Stock / in Market 2. These surprises are normally distributed; their mean is zero. The standard deviation of E1; and 2j for any two stocks, / and /, is 20 percent. Assume the correlation between the surprises in the returns of any two stocks in the first market is zero, and the correlation between the surprises in the returns of any two stocks in the second market is zero. a. What are the variances for the first and second market? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., .1616.) Market 1 Market 2 a-1.In which market would a risk averse person prefer to invest? Market 1 Market 2 Assume the correlation between 1/ and 1 in the first market is .8 and the correlation between 2/and 2/ in the second market is zero. b. What are the variances for the first and second market? (Do not round intermediate calculations and round your answers to 4 decimal places, e.g., 32.1616.) Market 1 Market 2
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