2. Consider data resulting from a regression of security returns on to market in
ID: 1175469 • Letter: 2
Question
2. Consider data resulting from a regression of security returns on to market index reflecting the market or single index model.
Security
Alpha
Beta
A
2.5
1.6
B
3.5
0.8
2.A. Calculate alpha and beta of a portfolio consisting in 30 % allocation to security A and 70% allocation to security B. Show the resulting single index model equation or market model equation. (15 points)
2.B: According to alpha and Beta of the portfolio you have calculated above in part A, if the market return is 10 % what would be (calculate) return on your portfolio. (10 points)
Security
Alpha
Beta
A
2.5
1.6
B
3.5
0.8
Explanation / Answer
We will first calculate the the portfolio Beta which is simply the weighted average of respective stock Beta.
Portfolio Beta = 30% * 1.6 + 70% * 0.8 = 1.04
Similarly the portfolio alpha is also weighted average : 30% * 2.5% + 70% 3.5% = 3.2%
The resulting equation will be : Expected Portfolio Return = 3.2% + 1.04 * (market return)
Part b. If the market return is 10%, then the above portfolio return will be = 3.2% + 1.04 * 10% = 13.60%
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