Suppose you group all the stocks in the world into two mutually exclusive portfolios (each stock is in only one portfolio): growth stocks and value stocks. Suppose the two portfolios have equal size (in terms of total value), a correlation of 0.5, and the following characteristics:

The risk-free rate is 3%.

a. What is the expected return and volatility of the market portfolio (which is a 50–50 combination of the two portfolios)?

b. Does the CAPM hold in this economy? Is the market portfolio efficient?

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Value Stocks Growth Stocks Expected Return 15% 16% Volatility 14% 20%