Based on the current dividend yields and expected capital gains, the expected rates of return on portfolios A and B are 12% and 16% respectively. The beta of A is 0.7, while that of B is 1.4. The T-bill rate is currently 5%, whereas the expected rate of return of the S & P 500 index is 13%. The standard deviation of portfolio A is 12% annually, that of B is 31%, and that of the S & P 500 index is 18%.

a) If you currently hold a market-index portfolio, would you choose to add either of these portfolios to your holdings? Explain. (6 marks) b) If instead you could invest only in T-bills and one of these portfolios, which would you choose? (6 marks)

c) Not relating to the above questions, what does the separation property tell about the portfolio choice between risk-free asset and risky assets? Explain your answer in detail. (8 marks)