FIN 540 CH 11 P7,10

# FIN 540 CH 11 P7,10 - 7 Portfolio Risk You are forming an...

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7. Portfolio Risk You are forming an equally weighted portfolio of stocks. Many stocks have the same beta of .84 for factor 1 and the same beta of 1.69 for factor 2. All stocks also have the same expected return of 11 percent. Assume a two-factor model describes the return on each of these stocks. a. Write the equation of the returns on your portfolio if you place only five stocks in it. Rp = SUM(Xi*Ri) (i= 1 to 5) Where: Rp = return of the portfolio Ri = actual return observed on asset i (i=1 to 5) Xi = proportion in asset i (i=1 to 5) Because this is a two factors model: Ri = Ei + beta_1*F1 + beta_2*F2 + e_i Where: Ei = expected return on asset i (i=1 to 5) F1 and F2 denote the factors in this model e_i = non-systematic or residual risk for asset i (i=1 to 5) For this problem for each stock we have that: Ri = 0.11 + 0.84*F1 + 1.69*F2 + e_i Xi = 1/5 for all i Rp = SUM(Xi*Ri) = (i= 1 to 5) = SUM(1/5*Ri) = = 1/5*SUM(0.11 + 0.84*F1 + 1.69*F2 + e_i) = = 1/5*5*(0.11 + 0.84*F1 + 1.69*F2) + 1/5*SUM(e_i) =

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FIN 540 CH 11 P7,10 - 7 Portfolio Risk You are forming an...

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