Question

Problem 8-10 Suppose that the index model for stocks A and B is estimated from excess returns with the following results: ERA = 2.0% + 0.40RM + eA RB = -1.8% + 0.9RM + eB OM = 15%; R-squarea = 0.30; R-squares = 0.22 Break down the variance of each stock to the systematic and firm-specific components. (Do not round intermediate calculations. Calculate using numbers in decimal form, not percentages. Round your answers to 4 decimal places.) Risk for A Risk for B Systematic Firm-specific

Answer 1

Variance of A=Beta A^2*Standard Deviation of M^2/Ra^2 =0.40^2*15%^2/0.30 =1.2%
Variance of of B=Beta B^2*Standard Deviation of M^2/Rb^2 =0.9^2*15%^2/0.22 =8.2841%


Systematic Risk of A=Beta A^2*Standard Deviation of M^2=0.40^2*15%^2=0.0036
Firm Specific risk of A =Variance of Risk A-Systematic Risk=0.0120-0.0036 =0.0084

Systematic Risk of B=Beta A^2*Standard Deviation of M^2=0.9^2*15%^2=0.0182
Firm Specific risk of B=Variance of Risk B-Systematic Risk=0.0828-0.0182 =0.0646