2. Find a low-risk stock—Exxon Mobil or Kellogg would be a good candidate. Use monthly returns for the most recent three years to confirm that the beta is less than 1.0. Now estimate the annual standard deviation for the stock and the S&P index, and the correlation between the returns on the stock and the index. Forecast the expected return for the stock, assuming the CAPM holds, with a market return of 12% and a risk-free rate of 5%.

a. Plot a graph like Figure 8.5 showing the combinations of risk and return from a portfolio invested in your low-risk stock and the market. Vary the fraction invested in the stock from 0 to 100%.

b. Suppose that you can borrow or lend at 5%. Would you invest in some combination of your low-risk stock and the market, or would you simply invest in the market?

Explain.

c. Suppose that you forecasted a return on the stock that is 5 percentage points higher than the CAPM return used in part (b). Redo parts

(a) and

(b) with the higher forecasted return.

d. Find a high-risk stock and redo parts

(a) and (b).