#### Srilakshmi

##### Member

The Answer that is given is:

a) Shorting an equally-weighted portfolio of the ten negative-alpha stocks and investing the proceeds in an equally-weighted portfolio of the ten positive-alpha stocks eliminates the market exposure and creates a zero-investment portfolio. Denoting the systematic market factor as RM, the expected dollar return is (noting that the expectation of non-systematic risk, e, is zero):

**$1,000,000 × [0.02 + (1.0 × Rm)] − $1,000,000 × [(−0.02) + (1.0 × Rm)] = $1,000,000 × 0.04 = $40,000**

The sensitivity of the payoff of this portfolio to the market factor is zero because the exposures of the positive alpha and negative alpha stocks cancel out. (Notice that the terms involving RM sum to zero.) Thus, the systematic component of total risk is also zero. The variance of the analyst’s profit is not zero, however, since this portfolio is not well diversified.

**Conceptually I can make sense but I am not sure of the return/profit calculation**

I am not able to understand the calculation of [0.02 + (1.0 × Rm)] and what happens to the returns calculated by the analyst? Is it just a sampling bias?

I am not able to understand the calculation of [0.02 + (1.0 × Rm)] and what happens to the returns calculated by the analyst? Is it just a sampling bias?