Answer to Question #272648 in Financial Math for cliffe

Question

1

1. Assume that a two-factor model is descriptive of reality, and determine the equation that describes the equilibrium returns for the following three portfolios:

Portfolio E (rp) bi1 bi2

D 10% 1.2 0.8

E 12 2 0.5

G 14 2.1 1.2

Hint: you must solve three equations in three unknowns simultaneously; a computer program (like 1-2-3, or some statistical software package) that does matrix inversion is the easiest way to solve the mathematics part of this problem.

b) Compare and contrast the intrinsic value with the time value for

(i) a call option and

(ii) a put option

2.The risk free rate is 10% and the expected return on the market portfolio is 15%. The expected returns for 4 securities are listed below together with their expected betas