Concept explainers
APT Assume that the following market model adequately describes the return generating behavior of risky assets:
Here:
Ru = The return on the ith asset at Time t.
RMt = The return on a portfolio containing all risky assets in some proportion at Tuner.
RMr and ∊u are statistically independent.
Short selling (i.e., negative positions) is allowed in the market. You are given the following information:
Asset | β1 | E(R1) | Var(∊1) |
A | .7 | 8.41% | 12.06 |
B | 1.2 | 13.95 | .0100 |
c | 1.5 | .0144 | .0225 |
The variance of the market is .0121, and there are no transaction costs.
- a. Calculate the standard deviation of
returns for each asset. - b. Calculate the variance of return of three portfolios containing an infinite number of asset types A, B, or C, respectively.
- c. Assume the risk-free rate is 3.3 percent and the expected return on the market is 10.6 percent. Which asset will not be held by rational investors?
- d. What equilibrium state will emerge such that no arbitrage opportunities exist? Why?
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