Forecast Returns, Standard Deviations, and Betas Forecast Return Standard Deviation Beta Low β stock (X) 14.0% 36% 0.8 High β stock (Y) 17.0% 25% 1.5 Market index 14.0% 15% 1.0 Risk-free rate 5.0% (a) Calculate expected return and alpha for each stock. (b) Identify and justify which stock would be more appropriate for an investor who wants to add this stock to a well-diversified equity portfolio.
Karen Kay, a
Her research department has developed the information shown in the following
exhibit.
Forecast Returns, Standard Deviations, and Betas
Forecast Return Standard Deviation Beta
Low β stock (X) 14.0% 36% 0.8
High β stock (Y) 17.0% 25% 1.5
Market index 14.0% 15% 1.0
Risk-free rate 5.0%
(a) Calculate expected return and alpha for each stock.
(b) Identify and justify which stock would be more appropriate for an investor
who wants to add this stock to a well-diversified equity portfolio.
(c) Now consider Karen employs the “Betting Against Beta” strategy and let
, , and denote the portfolio weights of the investment
in each of the asset classes (e.g. risk-free asset, low beta stock, market index,
high beta stock, respectively) such that .
According to its investment mandate, Collins Asset Management should
target a gross leverage of 2.3. How much does she have to invest in each asset
class?
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