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- Suppose that two stocks, A and B, have the same beta = 1. The standard deviations of the idiosyncratic returns for the two stocks,

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- Suppose that two stocks, A and B, have the same beta = 1. The standard deviations of the idiosyncratic returns for the two stocks, A and B, are the same and equal to 30% (Using the notation in our class, Oca OB = 30%). Suppose that an analyst uses CAPM to study the two stocks, and finds that stock A has an alpha of 2% and the stock B has an alpha of -2%. Suppose the analyst buys $10,000 of stock A, and short sells $10,000 of stock B. (Hint: If CAPM holds, then expected return of any stock i is R = Qi + Rp + Bi(Rm Rf)+ . Rf is the risk-free return, Rm is the market return and ti is the idiosyncratic return. The expectation of the idiosyncratic return for any stock is equal to 0%. Think about the covariance of idiosyncratic returns for any two stocks.) 5. What is the expectation and standard deviation of the analyst's profit (in dollars)? - Suppose that two stocks, A and B, have the same beta = 1. The standard deviations of the idiosyncratic returns for the two stocks, A and B, are the same and equal to 30% (Using the notation in our class, Oca OB = 30%). Suppose that an analyst uses CAPM to study the two stocks, and finds that stock A has an alpha of 2% and the stock B has an alpha of -2%. Suppose the analyst buys $10,000 of stock A, and short sells $10,000 of stock B. (Hint: If CAPM holds, then expected return of any stock i is R = Qi + Rp + Bi(Rm Rf)+ . Rf is the risk-free return, Rm is the market return and ti is the idiosyncratic return. The expectation of the idiosyncratic return for any stock is equal to 0%. Think about the covariance of idiosyncratic returns for any two stocks.) 5. What is the expectation and standard deviation of the analyst's profit (in dollars)

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