Assume that stock market returns do follow a single-index structure.An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments.They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
A)125; 15,225
B)15,625; 125
C)7,750; 125
D)125; 125
E)none of the above

Question

Quizplus · Accepted Answer

Since the investment fund assumes that stock market returns follow a single-index structure, they only need to estimate the sensitivity coefficients (beta) of each of the 125 stocks to the macroeconomic factor (i.e. the index), which gives us 125 estimates. The expected returns of the individual stocks can then be estimated using the index's expected return and each stock's sensitivity coefficient. Therefore, we only need to calculate 125 estimates of expected returns and 125 estimates of sensitivity coefficients. Thus, the correct answer is D.

Assume That Stock Market Returns Do Follow a Single-Index Structure