(a.) Carefully show how you would derive the Security Market Line from portfolio theory.

(b.) Suppose mutual fund 1 has a beta of 0.8 and is half as risky as mutual fund 2 when measured by the common factor (e.g. the stock market). The two assets have an expected return of 9% (mutual fund 1) and 12% (mutual fund 2) respectively.

(i.)For the two mutual funds to be correctly priced state the equation of the Security Market Line. What is the risk free rate and what is the market return?

(ii.)Suppose the risk free rate is 4% and the expected market return is 10%. Based on the CAPM, how would you assess the attractiveness of those two mutual funds ?

(c.) Explain what we understand by firm specific risk and how you could measure firm specific risk of a company, based on the CAPM.