Market over the next year are represented by the regression

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Reference no: EM131868037

Consider two stocks, A and B, with betas of 0.5 and 1.5, respectively. You believe that the annualized expected return of the market is E[rM] = 10%, the annual standard deviation of the market is σM = 0.20, and the risk-free rate is 5%. Finally, you believe that returns of A, B, and the market over the next year are represented by the regression:

(ri − rf) = αi + βi(rM − rf) + ei, for i = A, B

in which rA-rf is 0.04, rB-rf is 0.06, the R2 is 0.95 for both A and B, and where eA and eB are uncorrelated. Find the abnormal returns of these stocks (in excess of the returns predicted by the CAPM). Find the variance of portfolio P, composed of A and B with weights wA=70% and wB=30%.

Reference no: EM131868037

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