Scribd Logo
Upload

Welcome to Scribd!

  • Solution 7

    Uploaded by

    Shin Yuen
    175 views3 pages
    This document provides an in-class exercise on arbitrage pricing theory that involves a two-factor model for the returns of three stocks. It asks the reader to: 1) Calculate the variances, covariances, and correlations between the returns of the three stocks. 2) Determine the expected returns of each of the three stocks. 3) Write out the factor betas, factor equations, and expected returns for two portfolios - one consisting of long and short positions in the three stocks, and another adding a short position of one of the stocks to the first portfolio.

    Original Description:

    Copyright

    © Attribution Non-Commercial (BY-NC)

    Available Formats

    PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    Report this Document
    This document provides an in-class exercise on arbitrage pricing theory that involves a two-factor model for the returns of three stocks. It asks the reader to: 1) Calculate the variances, covariances, and correlations between the returns of the three stocks. 2) Determine the expected returns of each of the three stocks. 3) Write out the factor betas, factor equations, and expected returns for two portfolios - one consisting of long and short positions in the three stocks, and another adding a short position of one of the stocks to the first portfolio.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    175 views3 pages

    Solution 7

    Uploaded by

    Shin Yuen
    This document provides an in-class exercise on arbitrage pricing theory that involves a two-factor model for the returns of three stocks. It asks the reader to: 1) Calculate the variances, covariances, and correlations between the returns of the three stocks. 2) Determine the expected returns of each of the three stocks. 3) Write out the factor betas, factor equations, and expected returns for two portfolios - one consisting of long and short positions in the three stocks, and another adding a short position of one of the stocks to the first portfolio.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 3

    In-Class

    Exercise 7 Arbitrage Pricing Theory


    Question 1 Consider the following two-factor model for the returns of three stocks. Assume that the factors and epsilons have means of zero. Also, assume the factors have variance of 0.01 and are uncorrelated with each other.

    Assume:

    a) What are the variances of the returns of the three stocks, as well as the covariance and correlation between them? b) What are the expected returns of the three stocks? c) Write out the factor betas, factor equations, and expected returns of the following portfolios: i. A portfolio of the three stocks in above with $20,000 invested in stock A, -$20,000 invested in stock B, and $10,000 invested in stock C. ii. A portfolio consisting of the portfolio formed in part (i) and a $3,000 short position in stock C. Question 1 Solution a) What are the variances of the returns of the three stocks, as well as the covariance and correlation between them?

    b) What are the expected returns of the three stocks?

    c) Write out the factor betas, factor equations, and expected returns of the following portfolios: i. A portfolio of the three stocks in above with $20,000 invested in stock A, -$20,000 invested in stock B, and $10,000 invested in stock C.

    ii. A portfolio consisting of the portfolio formed in part (i) and a $3,000 short position in stock C.

    You might also like