1. Assume that the CAPM holds and that the expected return and standard deviation of the market portfolio are E[RM]=0.08 and M=0.15, respectively. The correlation between the return on the market portfolio and the return on stock A is AM=0.1. The expected return on stock A is E[RA]=0.03 and the standard deviation of the return on stock A is A=0.2. (a) What is the CAPM beta of stock A ? (b) What is the risk-free rate? There is another stock B that is perfectly negatively correlated with stock A, i.e., AB= -1 . The standard deviation of stock B is B=0.5. 1 (c) What is the covariance of stock B with the market portfolio? (d) What should the expected return on stock B be for it to be correctly priced by the CAPM? (e) Suppose the expected return on stock B is E[RB]=0.12, describe a strategy that would give you an arbitrage profit. In this strategy, you can trade stocks A and B as well as the risk-free asset at the risk-free rate that you computed in part (b). 1. Assume that the CAPM holds and that the expected return and standard deviation of the market portfolio are E[RM]=0.08 and M=0.15, respectively. The correlation between the return on the market portfolio and the return on stock A is AM=0.1. The expected return on stock A is E[RA]=0.03 and the standard deviation of the return on stock A is A=0.2. (a) What is the CAPM beta of stock A ? (b) What is the risk-free rate? There is another stock B that is perfectly negatively correlated with stock A, i.e., AB= -1 . The standard deviation of stock B is B=0.5. 1 (c) What is the covariance of stock B with the market portfolio? (d) What should the expected return on stock B be for it to be correctly priced by the CAPM? (e) Suppose the expected return on stock B is E[RB]=0.12, describe a strategy that would give you an arbitrage profit. In this strategy, you can trade stocks A and B as well as the risk-free asset at the risk-free rate that you computed in part (b)