Unformatted text preview: R A = 3% + 0.7R M + e A R B = 2% + 1.2R M + e B With σ M = 20% RSQ R A = 0.2 and RSQ R B = 0.12 a. What is the standard deviation of each stock? [4] b. Break down the variance of each stock to the systematic and firm specific components [6] c. What is the covariance between each stock and the market index? [4] d. Are the intercepts of the two regressions consistent with the CAPM? Interpret their values. [4] Question Three Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums. Factor Risk Premium Industrial production (I) 6% Interest rates (R) 2% Consumer confidence (C) 4% The return on a particular stock is generated according to the following equation: e C 75 . R 5 . I 1 % 15 r + + + + = Find the equilibrium rate of return on this stock using the APT. The Tbill rate is 6%. Is the stock over or underpriced? Explain. [6]...
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 Summer '09
 DrToerien
 Finance

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