Can you helo with these? Thank you. 1. a portfolio is composed of stocks A and B
ID: 2383052 • Letter: C
Question
Can you helo with these? Thank you.
1. a portfolio is composed of stocks A and B. The weight of A is 0.6 and the variance is 0.4. The covariance of A and B is -0.25. Assume that such a portfolio reaches its minimum variance, What is the variance of B?
2.
The risk-free rate is 2%. The expected return of the market portfolio is 12%. The beta of a stock is 1.5 and the expected return of this stock is 14%. Which trading strategy should an investor adopt?
a.Do nothing
b. Sell short this stock because it is overpriced
c. Sell short this stock because it is underpriced
d. Buy this stock because it is overpriced
e. Buy this stock because it is underpriced
3.
A portfolio P is composed of two risky stocks A and B whose expected returns are 12% and 20%, respectively. The expected return of P is 16%. The betas of P and A are 1.5 and 1.2, respectively. The expected return of the market portfolio is 10%. Finally, stock A’s return is thought overestimated by 1%.
a. What is the beta of B?
b. What is the alpha of B?
Explanation / Answer
Portfolio risk is minimum since variance is minimum.
Thus, Portfolio variance = +1
Weight of secuirty B = 0.4
Portfolio Variance = W12.Variance1 + W22.Variance2 + 2. W1.W2.r12.Variance1. Variance2
-1 = 0.62. (0.4) + 0.42. Variance2 + 2.(0.6).(0.4). (-0.25). (0.4). Variance2
-1 = 0.144 + (0.16). Variance2 - 0.048 . (Variance2)
Variance2 =- 10.21
2. Expected return = Rf + Beta (Rm - Rf)
Expected return = 2 + 1.5(12-2) = 17%
Return of the stock = 14%
Thus, it is underpriced security.
e. is the correct answer. Buy this stock as it is underpriced.