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as372w10a4 - ActSc 372 WINTER 2010 Assignment 4 Due Date...

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ActSc 372 WINTER 2010 Assignment 4 Due Date: Wednesday, March 10, 2010 (Beginning of Class) 1. Assume that the returns of individual securities are generated by the following two- factor model: R i = E ( R i ) + β i F 1 + β i F 2 , where R i is the return for security i and F 1 and F 2 are market factors with zero expectation and zero covariance. In addition, assume that there is a capital market for four securities, and the capital market for these four assets is perfect in the sense that there are no transaction costs and short sales are permitted. The characteristics of the four securities follow: Security β 1 β 2 E ( R ) 1 1.0 1.5 20% 2 0.5 2.0 20% 3 1.0 0.5 10% 4 1.5 0.75 10% (a) Construct a portfolio containing (long or short) securities 1 and 2, with a return that does not depend on the market factor F 1 in any way. Compare the expected return and β 2 coefficient for this portfolio. (b) Following the procedure in (a), construct a portfolio containing securities 3 and 4 with a return that does not depend on the market factor F 1 . Compare the

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