Question: Two risky assets have returns generated by the single factor (CAPM) model R 1 R f = 2(R m - R f )+ e 1

Two risky assets have returns generated by the single factor (CAPM) model

R1 Rf = 2(Rm - Rf)+ e1.

R2 Rf = 0.8(Rm - Rf)+ e2.

Stdev(Rm) = 0.20, stdev(e1) = stdev(e2) = 0.20, and covar(e1,e2) = 0. Rf = 0.02 is the riskfree rate. Stdev is short for standard deviation (square root of variance).

  1. Compute the standard deviation of asset 1, asset 2, and their covariance.
  2. Compute the of the equal-weighted portfolio of the two stocks.
  3. Suppose E[Rm] = 0.10. Compute the expected return on the equal-weighted portfolio of stocks 1 and 2.

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