Question

Assume that the returns on individual securities are generated by the following two-factor model:

  

Rit=E(Rit)+βijF1t+βi2F2tRit=E(Rit)+βijF1t+βi2F2t

  

Here:

Rit is the return on Security i at Time t.

F1t and F2t are market factors with zero expectation and zero covariance.

  

In addition, assume that there is a capital market for four securities, and the capital market for these four assets is perfect in the sense that there are no transaction costs and short sales (i.e., negative positions) are permitted. The characteristics of the four securities follow:

  

Security	β1	β2	E(R)
1	2.50	2.00	30	%
2	1.25	2.50	30
3	1.50	1.00	20
4	2.10	1.40	20

b.	Construct a portfolio containing Securities 3 and 4, with a return that does not depend on the market factor, F1t, in any way. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)

X3
X4

  

b-1.	Compute the expected return and β2 coefficient for this portfolio. (Do not round intermediate calculations and enter your expected return answer as a percent. Round your answers to the nearest whole number. Leave no cells blank - be certain to enter "0" wherever required.)

  

Expected return	%
β2

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