The Index Model Has Been Estimated for Stocks a and B

question 60

Multiple Choice

The index model has been estimated for stocks A and B with the following results: R_A = 0.01 + 0.5R_M + e_A.
R_B = 0.02 + 1.3R_M + e_B.
Σ_M = 0.25; σ(e_A) = 0.20; σ(e_B) = 0.10.
The covariance between the returns on stocks A and B is

• A) 0.0384.
• B) 0.0406.
• C) 0.1920.
• D) 0.0050.
• E) 0.4000.

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Definitions:

Pre-tax Cost

The expense or cost associated with an investment or project before any taxes are deducted.

Marginal Tax Rate

The rate at which your last dollar of income is taxed, indicating the percentage of tax applied to your next dollar of taxable income.

Coupons

The interest payments made to bondholders, typically on an annual or semi-annual basis.