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The index model has been estimated for stocks A and B with the following results: RA...

The index model has been estimated for stocks A and B with the following results:

RA = 0.01 + 0.8RM + eA.

RB = 0.02 + 1.1RM + eB.

σM = 0.30 σ(eA) = 0.20 σ(eB) = 0.10.

The covariance between the returns on stocks A and B is

Select one:

a. 0.0384.

b. 0.0406.

c. 0.1920.

d. 0.0050.

e. 0.0792.

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Answer #1

COVARIANCE OF RETURNS ON STOCK A AND B = Beta of stock A x Beta of stock B x Variance of market

Covariance = 0.8 x 1.1 x 0.302 = 0.0792

Answer : e : 0.0792 [Thumbs up please]

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