Write the equation of the returns on your portfolio if you have 5 stocks or a very large # of stocks in it.
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You are forming an equally weighted portfolio of stocks. There are many stocks that all have the same beta of 0.84 for factor 1 and the same beta of 1.69 for factor 2. All stocks also have the same expected return of 11 percent. Assume a two-factor model describes the returns on each of these stocks.
a. Write the equation of the returns on your portfolio if you place only five stocks in it.
b. Write the equation of the returns on your portfolio if you place in it a very large number of stocks that all have the same expected returns and the same betas.
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Solution Summary
This solution provides the equation of the returns on a portfolio.
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a.
Legend
Rp =Return on Portfolio
Ri = Actual Return on Asset i
Xi = Proportion in asset i
Rp = Summation (Ri * Xi)
For a two factor model:
Ri = Ei + B_1*F1 + B_2*F2 + e_i
Where:
Ei = expected ...
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