Consider a very simple world in which there are only two risky stocks, A and B, and a risk-free asset F. Details for stocks A and B are listed in the following table. 

                Stock        Shares outstanding        Price/Share       Exp. return       Std. dev.  

                  A                     100                                $1.50                15%                 15%

                  B                      150                                 $2.00                12%                 9%

The correlation coefficient between returns on stocks A and B is 1/3. Assuming that CAPM holds:

a) What is the expected rate of return of the market portfolio? Hint: The market portfolio has the form M= w_A*A+ w_B*B. Find portfolio weights w_A and w_B first. (1pt, Answer format: 14.20, in percent, but include no % symbol, round to 2 digits.)

b) What is the standard deviation of the market portfolio? (1pt, Answer format: 14.20, in percent, but include no % symbol, round to 2 digits.)

c) What is the beta of stock A? Hint: Note that Cov(r_M, r_A)= w_A*Cov(r_A, r_A)+ w_B*Cov(r_B, r_A). (1pt, Answer format: 1.20, round to 2 digits.)

d) What is the risk-free rate? Hint: Apply SML to stock A. (1pt, Answer format: 14.20, in percent, but include no % symbol, round to 2 digits.)

Answer rating: 100% (QA)

a To find the expected rate of return of the market portfolio rM you first need to calculate the portfolio weights wA and wB of stocks A and B in the ... View the full answer