<html>
<head>
<style>
.hmmessage P
{
margin:0px;
padding:0px
}
body.hmmessage
{
font-size: 10pt;
font-family:Verdana
}
</style>
</head>
<body class='hmmessage'>
<br>Hello Professor,<br><br>For problem 3, we are given sensitivity coefficient (B) and Expected <br>returns E(r), however to use two portfolios to derive at the common <br>factor (m) for this one-factor model, we still need a remainder risk (alpha). Then using the factor, we derive at security retun r(i). My question is: is this alpha the same for all three equations? Only with aplha being the same, can we derive at R(m).<br><br>How is it possible for this remainder risk to be the same for all three portfolios? Is this an assumption we make for the sake of the <br>problem?<br><br>Following are the equations I am using to derive first at R(m) and then at alpha. I am probably not using correct formulas for appropriate calculations, as my answers are incompatible with yours.<br><br>a = alpha; m = factor<br>Solving for m:<br>For A: 12 = a + 2m<br>For B: 15 = a + 3m<br>For C: 10 = a + m<br> <br>I obtained m = 3, and a = 6. Using m only I solved for r(i) = E(r) + m<br>For A, r(a) = 18<br>For B, r(b) = 24<br>For C, r(c) = 13<br> <br>Please Advise!<br><br>Thanks,<br>Eishita<br>> ><br>> > <br>> > > Date: Sun, 26 Apr 2009 18:26:31 -0500<br>> > > From: agehr@mozart.depaul.edu<br>> > > To: fin525sp09@mailman.depaul.edu<br>> > > Subject: Re: [Fin525sp09] Question on Midterm problem #3<br>> > ><br>> > > You don't need a risk-free rate. All you need to do is buy and sell<br>> > > portfolios which have the same factor-sensitivities. With three<br>> > > securities you can find a combination of two which replicate the factor<br>> > > sensitivity of the third (and it doesn't matter which you pick--you <br>> > will<br>> > > get the same result). Check the expected returns to find out which to<br>> > > sell and which to buy. If you get the same return on all combinations<br>> > > with the same factor sensitivity, you have an equilibrium. Otherwise <br>> > you<br>> > > have an arbitrage opportunity.<br>> > ><br>> > > In this example, I'd try to find the easiest way to mix<br>> > > securities--combine the high and low sensitivity securities to match <br>> > the<br>> > > sensitivity of the middle one. Then calculate expected returns.<br>> > ><br>> > > Adam Gehr<br>> > ><br>> > ><br>> > ><br>> > > patrick Redmond wrote:<br>> > > > Professer Gehr -<br>> > > ><br>> > > > I do not understand question #3 on the sample midterm; could you<br>> > > > provide some information on this probem?<br>> > > ><br>> > > > Spcifically, how to start this problem without a Risk-free rate. I<br>> > > > understand how to constitute an arbitrage, but not with the<br>> > > > information provided.<br>> > > ><br>> > > > Thanks in advance for your help,<br>> > > ><br>> > > > Kevin Redmond<br>> > > ><br>> > > > <br>> > ------------------------------------------------------------------------<br>> > > > Rediscover HotmailŪ: Get quick friend updates right in your inbox.<br>> > > > Check it out.<br>> > > > <br>> > <http://windowslive.com/RediscoverHotmail?ocid=TXT_TAGLM_WL_HM_Rediscover_Updates2_042009> <br>> ><br>> > > ><br>> > > > <br>> > ------------------------------------------------------------------------<br>> > > ><br>> > > > _______________________________________________<br>> > > > Fin525sp09 mailing list<br>> > > > Fin525sp09@mailman.depaul.edu<br>> > > > http://mailman.depaul.edu/mailman/listinfo/fin525sp09<br>> > > ><br>> > ><br>> > > _______________________________________________<br>> > > Fin525sp09 mailing list<br>> > > Fin525sp09@mailman.depaul.edu<br>> > > http://mailman.depaul.edu/mailman/listinfo/fin525sp09<br>> ><br>> > ------------------------------------------------------------------------<br>> > Rediscover HotmailŪ: Get quick friend updates right in your inbox. <br>> > Check it out. <br>> > <http://windowslive.com/RediscoverHotmail?ocid=TXT_TAGLM_WL_HM_Rediscover_Updates2_042009><br>> <br><br /><hr />Rediscover HotmailŪ: Now available on your iPhone or BlackBerry <a href='http://windowslive.com/RediscoverHotmail?ocid=TXT_TAGLM_WL_HM_Rediscover_Mobile2_042009' target='_new'>Check it out.</a></body>
</html>