Question: Suppose the Capital Asset Pricing Model (CAPM)) is valid in a simple market. Use CAPM to explain and answer following questions. Note: There is

Suppose the Capital Asset Pricing Model (CAPM)) is valid in a simple market. Use CAPM to explain and answer following questions. Note: There is no relationship between each situation. (a) Explain why risk-free portfolio has 8=0? Why BM=1? (b) Can the following portfolios A and B exist in the market? (Hint: Security market line) If yes, compute the corresponding risk premium on portfolio A and/or B. If not, explain the reason. Draw the corresponding security market line and mark the market portfolio as well as the portfolio A and B. Portfolio Risk-free Expected Return Beta 5% 0 Market 9% 1 A 11% 1.5 B 10.5% 1.2 (c) Can these following portfolio exist in the market? (Hint: Capital market line) If yes, compute the corresponding risk premium. If not, explain the reason. Draw the cor- responding capital market line and mark the market portfolio as well as the portfolio C and D. 2 Portfolio Risk-free Expected Return Standard Deviation 5% 0 Market 9% 12% C 13% 18% D 15% 40%

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