Note: $(1),(2)$ & $(3)$ share the same assumptions.

$(1)$ Suppose the simple CAPM is valid and all portfolios are priced correctly. The expected return of market

portfolio is $6\%.$ Please conclude whether the expected return of each portfolio in the below tables is reasonable

and explain why? $($Consider each situation independently, and assume the risk$-$free rate is $1\%.)$

$(2)$ However, in reality, CAPM may not hold. List at least two reasons why CAPM does not hold.

$(3)$ When CAPM fails in the pricing of stocks, we can introduce additional factors $($besides market portfolio

return premium$)$ to our pricing model. Now suppose there is an economic factors $x$ which is independent from

market factor. Portfolios A in the below table is well diversified.

$($a$)$ What is the expected return$-$beta relationship in this economy? $($In other words, write down the equation

describing how portfolio expected returns depend on the value of betas$)($Hint: when you add a new factor to

CAPM model, the new factor's risk premium is additive which means you simply add to the standard CAMP.$)$

$($b$)($Bonus $2\%)$ Can you give an example of an additional factor and explain why you think it matters.