Suppose the risk free rate is r_f = 2% and the expected return on the market is r_m = 6%. Using return data on two assets, asset 1 and asset 2, as well as the market, your investment bank has computed the variances and covariances summarized in the table below:

 

σ²1 = 0.25	σ1,2 = 0.10	σ1,m = 0.08
σ2,1 = 0.10	σ²2 = 0.09	σ2,m = 0.03
σm,1 = 0.08	σm,2 = 0.03	σ²m = 0.04

 

where σ²_i is the variance of asset i and σ_i,j is the covariance of asset i and asset j. a.) What are the expected returns on asset 1 and asset 2 according to the CAPM?

b.) What is the expected return and the standard deviation of a portfolio that has 40% invested in asset 1 and 60% in asset 2?

 

c.) What is the beta of this portfolio (β_p,m)?

 

d.) Assume the CAPM holds. Construct an efficient portfolio that has the same standard deviation as the portfolio in (b). 

i) what are the portfolio weights of the market asset and the Rf asset?

ii) What is the expected return of this portfolio? 

Answer rating: 100% (QA)

Answers to your CAPM questions a Expected returns of assets 1 and 2 To calculate the expected returns using CAPM we need the betas of each asset with respect to the market These can be calculated using the covariance formulas provided 1 1m m 008 004 2 2 2m m 003 004 075 Now using the CAPM formula Expected return ... View the full answer