Question: The riskless interest rate is 2%, and the mean return on the market portfolio of risky assets is 8%. You are analyzing three individual stocks.

The riskless interest rate is 2%, and the mean return on the market portfolio of risky assets is 8%. You are analyzing three individual stocks. The first has a mean return of 5.5% and a beta of 0.5. The second has a mean return of 6.5% and a beta of 0.75. The third has a mean return of 10% and a beta of 1.5. 1) Draw the security market line and plot the position of each individual stock in relation to it. 2) Calculate the alpha for each stock. Which of the three stocks, if any, obeys the prediction of the CAPM? 3) What investment strategy is suggested by your analysis in parts 1) and 2)?

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