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Standard deviation of securities- Two factor model

On the basis of a two-factor model, consider two securities with the following characteristics:

Characteristic Security A Security B
Factor 1 sensitivity 1.5 .7
Factor 2 sensitivity 2.6 1.3
Nonfactor risk 25.0 16.0

The standard deviations of factor 1 and factor 2 are 20% and 15%, respectively, and the factors have a covariance of 255. What are the standard deviations of securities A and B ? what is their covariance ?

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Solution Preview

On the basis of a two-factor model, consider two securities with the following characteristics:

Characteristic Security A Security B
Factor 1 sensitivity 1.5 .7
Factor 2 sensitivity 2.6 1.3
Nonfactor risk ...

Solution Summary

The solution shows steps to calculate the standard deviation and covariance of securities using the two factor model.
The attached Excel file shows all the steps.

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