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Unit 12: Models




          12.  Sharpe assumed that, the return on a security could be regarded as being ............... related  Notes
               to a single index like the market index.
          13.  Predicting the value of beta can be a ............... process.

          14.  In Markowitz Model, it is assumed that for a given risk level, investors prefer ...............
               returns to ............... returns.
          15.  In Markowitz Model, to build an efficient portfolio an ............... level is chosen, and assets
               are substituted until the portfolio combination with the smallest variance at return level
               is found.

          12.8 Review Questions


          1.   Define and explain the Fama-French 2-factor empirical model. Does it work in practice? Is
               it theoretically plausible? Discuss.
          2.   From the information given below, calculate each stock’s expected return. Using these
               individual security’s expected returns, compute the portfolio’s expected return.

               Stock       Initial Investment   Expected End-of-Period   Proportion of
                              Value (in  )       Investment Value     Portfolio’s Initial
                                                      (in  )         Market Value (%)

                   A            5,000                   7000                20.0
                   B            2,500                  4,000                10.0
                   C            4,000                  5,000                16.0
                   D           10,000                  12,000               40.0
                   E            3,500                  5,000                12.0

          3.   KK provides  you following information consider an efficient  portfolio with expected
               return of 15% and standard deviation of 12%. Suppose that the lowest variance portfolio
               with zero correlation with the efficient portfolio has an expected  rate of return of 5%.
               Next, assume that security i has a standard deviation of 20% and a correlation coefficient
               of 0.6 with the efficient portfolio. What does the expected rate of return on the asset have
               to be in order to be consistent with the mathematical relationship for efficient portfolios?
          4.   Mr. Rajeev provides you following information based on his assumption of the risk-index
               model, what is the residual variance of each of the following stocks:

                Stock        Portfolio        Beta         Expected         Total
                              Weight                        Return        Variance
                 A             0.25           0.50           0.40           0.07
                 B             0.25           0.50           0.25           0.05

                 C             0.50           1.00           0.21           0.07
                                   2 m  = 0.06
          5.   The standard deviation of return is 4.5% on equity shares of Bharathi Infotel Company,
               3.5% for Reliance Infocom Company, and 2.5% for the market portfolio. The correlation
               coefficient of Bharathi Infotel company for the market if +0.075 and Reliance Infocom to
               the market is – 0.5. What is the beta coefficient for Bharathi Infotel and Reliance Infocom?






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