exo3f - Econ 333 Financial Economics Spring 08 Homework#3...

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Econ 333 - Financial Economics Spring 08 Homework #3 Exercise 1: Do exercise 17 on page 314 of the main textbook (Ross and al.). Exercise 2: Do exercise 29 on page 316 of the main textbook (Ross and al.). Exercise 3: Do exercise 32 on page 316 of the main textbook (Ross and al.). Exercise 4: Consider the following two-factor model for the returns of three stocks. Assume that the factors and epsilon have means of zero. Also assume the factors have variances of 0.01 and are uncorrelated with each other. e r A = 0 . 13 + 6 e F 1 + 4 e F 2 + e ε A e r B = 0 . 15 + 2 e F 1 + 2 e F 2 + e ε B e r C = 0 . 07 + 5 e F 1 - 1 e F 2 + e ε C . If var ( e ε A ) = 0 . 01 , var ( e ε B ) = 0 . 4 , var ( e ε C ) = 0 . 02 . a - What are the variances of the returns of the three stocks, as well as the covariances and correlations between them? b - What are the expected returns of the three stocks? c - How much should be invested in each of these stocks to design two portfolios? The first portfolio has the following attributes: factor 1 beta =1 factor 2 beta = 0. The second portfolio has the attributes: factor 1 beta =0 factor 2 beta =1 Compute the expected returns of these two portfolios. Then compute the risk premiums
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