The following table shows the expected return (E(ri)), the standard deviation (si), the cor- relation with the market portfolio (ri,M), the market beta (bi), and the idiosyncratic risk expressed as a standard deviation (se,i), for a number of assets, namely, the risk-free asset, the market portfolio, and three risky stocks (1, 2, and 3). You can assume for this question that the CAPM holds.

Asset	expected return	standard deviation	cor- relation with the market portfolio	market beta	idiosyncratic risk expressed as a standard deviation
Risk-free asset (rF )
Market portfolio (M)	10%
Stock 1	8%	15%		0.75
Stock 2	18%	80%	0.25
Stock3	-4%	7.5%			0

(a) Fill in all the blanks in the table. Make sure you show your workings and the reasoning behind the numbers you obtain. 

(b) Given that Stock 3 has a negative expected return, why would an investor buy it? Could Stock 3 be part of an efficient portfolio and why? 

(c) Consider now a portfolio composed of the market M and stock 3. What weights should we assign to these two assets in order to obtain a riskless portfolio? What will be the expected return of this portfolio? 

Answer rating: 100% (QA)

Risk free asset has ZERO 0 standard deviation si ZERO 0 correlation with the market portfolio riM ZERO 0 market beta bi and ZERO 0 idiosyncratic risk ... View the full answer