Assume that the following results are the index model for stock A and B estimated from the excess returns with and risk=standard deviation.

Significance level for the coefficient is 90% confidence interval

Stock A

Stock B

Alpha

1%

1.30%

alpha P-value

1.00%

8.00%

Beta

0.5

0.8

beta P-value

1.00%

0.00%

firm specific risk

18%

22%

weights in P (arbitrary)

60%

40%

Market risk is 18% and market expected return is 5%. Given that the market expected excess return of 5%, what are the expected excess returns of stock A and B? What is the total risk for each stock? Which stock would you choose if you were to take an active position, , A or B? Why? What is the covariance between each stock and the market index and between the two stocks? For Portfolio P with investment proportions of 0.6 in A and 0.4 in B, what is the covariance of portfolio P with the market index?

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