3.10 Problems: Matrix Algebra Review
Exercise 3.1 Use R to answer the following questions.
- Create the following matrices and vectors \[ \mathbf{A}=\left[\begin{array}{ccc} 1 & 4 & 7\\ 2 & 4 & 8\\ 6 & 1 & 3 \end{array}\right],\,\mathbf{B}=\left[\begin{array}{ccc} 4 & 4 & 0\\ 5 & 9 & 1\\ 2 & 2 & 5 \end{array}\right],\,\mathbf{x}=\left[\begin{array}{c} 1\\ 2\\ 3 \end{array}\right],\,\mathbf{y}=\left[\begin{array}{c} 5\\ 2\\ 7 \end{array}\right] \]
- Compute the transposes of the above matrices and vectors.
- Compute \(\mathbf{A}+\mathbf{B},\:\mathbf{A}-\mathbf{B},\,2\mathbf{A},\,\mathbf{Ax},\,\mathbf{AB,\,y^{\prime}Ax}\)
Exercise 3.2 Consider the system of linear equations
\[\begin{eqnarray*}
x+y & = & 1\\
2x+4y & = & 2
\end{eqnarray*}\]
- Plot the two lines and note the solution to the system of equations. Hint: you can use the R functions
abline()
orcurve()
to plot the lines. - Write the system in matrix notation as \(\mathbf{Az}=\mathbf{b}\) and solve for \(\mathbf{z}\) by computing \(\mathbf{z}=\mathbf{A}^{-1}\mathbf{b}\).
Exercise 3.3 Consider creating an equally weighted portfolio of three assets denoted
A, B, and C. Assume the following information
\[
\mu=\left[\begin{array}{c}
0.01\\
0.04\\
0.02
\end{array}\right],\,\Sigma=\left[\begin{array}{ccc}
0.10 & 0.30 & 0.10\\
0.30 & 0.15 & -0.20\\
0.10 & -0.20 & 0.08
\end{array}\right].
\]
Use R to answer the following questions.
- Create the vector of portfolio weights.
- Compute the expected return on the portfolio.
- Compute the variance and standard deviation of the portfolio.
Exercise 3.4 Let \(R_{i}\) be a random variable denoting the simple return on asset
\(i\,(i=1,\ldots,N)\) with \(E[R_{i}]=\mu_{i},\) \(\mathrm{var}(R_{i})=\sigma_{i}^{2}\)
and \(\mathrm{cov}(R_{i},R_{j})=\sigma_{ij}.\) Define the \(N\times1\)
vectors \(\mathbf{R}=(R_{1},\ldots,R_{N})^{\prime},\) \(\mu=(\mu_{1},\ldots,\mu_{N})^{\prime},\)
\(\mathbf{x}=(x_{1},\ldots,x_{N})^{\prime},\) \(\mathbf{y}=(y_{1},\ldots,y_{N})^{\prime},\)
and \(\mathbf{1}=(1,\ldots,1)^{\prime}\), and the \(N\times N\) covariance
matrix
\[
\Sigma=\left(\begin{array}{cccc}
\sigma_{1}^{2} & \sigma_{12} & \cdots & \sigma_{1N}\\
\sigma_{12} & \sigma_{2}^{2} & \cdots & \sigma_{2N}\\
\vdots & \vdots & \ddots & \vdots\\
\sigma_{1N} & \sigma_{2N} & \cdots & \sigma_{N}^{2}
\end{array}\right).
\]
The vectors \(\mathbf{x}\) and \(\mathbf{y}\) contain portfolio weights
(investment shares) that sum to one. Using simple matrix algebra,
answer the following questions.
- For the portfolios defined by the vectors \(\mathbf{x}\) and \(\mathbf{y}\) give the matrix algebra expressions for the portfolio returns \(R_{p,x}\) and \(R_{p,y}\) and the portfolio expected returns \(\mu_{p,x}\) and \(\mu_{p,y}\).
- For the portfolios defined by the vectors \(\mathbf{x}\) and \(\mathbf{y}\) give the matrix algebra expressions for the constraint that the portfolio weights sum to one.
- For the portfolios defined by the vectors \(\mathbf{x}\) and \(\mathbf{y}\) give the matrix algebra expressions for the portfolio variances \(\sigma_{p,x}^{2}\) and \(\sigma_{p,y}^{2}\), and the covariance between \(R_{p,x}\) and \(R_{p,y}\).
- In the expression for the portfolio variance \(\sigma_{p,x}^{2}\), how many variance terms are there? How many unique covariance terms are there?