1. Draw an ideal SML. Based on the early empirical results, what did the actual riskreturn relationship look like relative to the ideal relationship implied by the CAMP? (3marks)
2. Given are states, probabilities, and returns of two securities A and B. Consider the returns of these securities which rely on the states of nature as given below:

Returns %

State of nature Probability A B

Recession 0.3 10 5

Stable 0.4 15 7.5

Expansion 0.3 10 5

Use the above given data to:

a) Estimate the expected returns of A and B. (4marks)

b) Compute the standard deviation of the individual securities (4arks)

c) Find out the correlation coefficient between the two securities returns and comment. (3marks)

d) Work out the portfolios expected return for a portfolio consisting of 60% of A and 40% of B. (1mark)

e) Evaluate the risk of the portfolio in (d) above. (3marks)