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Covariance between the returns on stocks a and b

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Reference no: EM132801985

The index model has been estimated for stocks A and B with the following results:

RA= -0.06 + 0.85RM+ eA

RB= 0.03 + 2.95RM+ eB

The standard deviation of the market index is 18%; the residual standard deviation of the error terms for stock A is 44%; the residual standard deviation of the error terms for stock B is 35%.

a) What is the covariance between the returns on stocks A and B?

b) What is your best estimate of the total variance of the excess returns on stock B?

c) What is your best estimate of the R-Squared in the regression of stock B on the market index M?

d) You want to form a complete portfolio with 60% invested in Stock A, 25% invested in Stock B, and 15% invested in a risk-free asset with expected return of 3%, beta of 0, and residual standard deviation of 0%. Using the Index Model, what is your estimate of the standard deviation of this complete portfolio?

Reference no: EM132801985

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